When you’re running a business, a certain amount of debt is normal. But it’s crucial for you to know when your business is taking on too much debt, and what you can do when it is. 

In this article, we’ll be explaining the basics of solvency in business, and eight ways to improve it. Specifically, we’ll be covering:

  • What is solvency in business?
  • Why is solvency important?
  • How to measure solvency.
  • 8 ways to improve solvency in business. 

What is solvency in business?

Solvency describes a business’ ability to pay off its long-term financial debts. In other words, it’s a business’ assets compared to its liabilities. If a business doesn’t have enough assets to cover the cost of its liabilities, it’s referred to as insolvent. 

Solvency is often confused with liquidity, but liquidity is only concerned with short-term debts. The two are often calculated together to get a better overall view of a business’ financial situation.

Why is solvency important?

It’s necessary to take on a certain amount of debt in order to grow your business, but having too much without the assets to pay it back can lead to difficulties. 

That’s why solvency is often measured next to liquidity; businesses need to find the right balance between short-term, long-term debt, assets, and income.

How to measure solvency

There are three basic ways to measure the solvency of a business. They’re all ratios that measure different kinds of value against debt:

  • Debt-to-asset ratio
  • Debt-to-equity ratio
  • Debt-to-cash flow ratio

It’s important to mention that there are some things that can affect solvency that might not show up in your calculations, things that might affect your ability to produce income.  

For example, a change in legislation or tax codes could have a direct impact on your cash flow or profits. 

Debt-to-asset ratio

Also called “debt ratio”, it compares your assets to your liabilities. 

A lower debt-to-asset ratio shows you should always have the money available (through selling assets) to pay back debts, so your business will look less risky to investors and banks.

Debt-to-equity ratio

Companies with shareholder equity can use this to measure solvency. 

Equity is the total value of a company after all its assets are liquidated and liabilities are paid, so comparing shareholder equity to debt is a good indicator of a company’s financial situation. 

Debt-to-cash flow ratio

The amount of available cash a business has compared to its long-term liabilities. 

Debt-to-cash flow ratio shows how easily a business can repay its debts without having to sell any of its assets. 

8 ways to improve solvency in business

Improving solvency comes down to changing those ratios we mentioned above. Generally speaking, the best way to do this is by managing your debt and cash flow

Reduce your debt

Reducing your debt is the first half of the battle. And there are a few things you can do to help. 

1) Prioritise your debts

Figure out which debts need to be paid immediately and focus on them first. 

High priority debts are any that could get you in trouble legally, interrupt business operations, or lead to further financial trouble if they’re not paid on time. Some examples include:

  • Business rates.
  • Utility bills.
  • Mortgage and rent payments.
  • Tax bills.
  • Payments to strategic suppliers.
  • Bank loans.
  • FIxed or variable business loans.
  • Anything where you’ve put your name down as a personal guarantee.

2) Restructure your debt

Restructuring your debt can prevent you from defaulting on a loan. Restructuring could help by:

  • Turning different loans into one, more affordable, one. 
  • Lowering the interest rate on the loan. 
  • Extending the repayment period. 

There are companies out there that will give you advice and help you with debt restructuring. You should get in touch with them before trying to do anything on your own. 

3) Negotiate better payment terms

If you’re dealing with independent lenders and creditors, you could talk to them directly about changing the payment terms of your debt.

If you’re going to take this route, here are a few helpful tips:

  • Approach them with the idea before you default on a payment.
  • Explain the situation and how you plan to improve it.
  • Stay positive, reinforcing the fact that you want to pay them back. 

Most lenders will be open to a negotiation like this. After all, they definitely want their money back, so it’s in their best interest.

4) Cut unnecessary costs

Unnecessary costs would be anything that you don’t need to continue business operations, like luxury items and benefits. 

You should also find cheaper suppliers for stock, subscriptions, and insurance. And don’t automatically renew any contracts you already have without looking at them first. 

Increase your cash flow

On top of managing your business debt, you can also improve solvency by gaining more assets. This will mainly involve increasing your cash flow. 

5) Increase your customer base

The most straightforward way to increase your cash flow is by finding new customers. Some strategies include:

  • Analysing customer behaviour to look for areas of improvement. 
  • Using customer feedback. 
  • Learning from your successful competitors.
  • Social media marketing.
  • Email marketing.
  • Partnering with other businesses.
  • Customer referral programmes.

6) Increase the average amount your customers spend 

As well as increasing your customer you should focus on increasing the amount each customer spends. You can achieve this through:

  • Upselling. 
  • Offering free shipping on deliveries. 
  • Improving customer experience. 
  • Introducing reward programmes for loyal customers. 

7) Increase the number of times a customer makes a purchase

Once you have a base of regular customers, you should try to increase the number of times they interact with your business and make a purchase.

Whether your business is exclusively online, or you have a physical store too, automated emails are a great way to get customers visiting your business. 

You can program emails to trigger after certain amounts of time or when customers make certain actions. For example, you can send:

  • Weekly/monthly newsletters to customers on your mailing list. 
  • Information about products that are similar to ones they’ve already bought. 
  • Promotional information or discount codes. 
  • Emails to loyal customers with early access information about new products. 
  • Reminder emails if customers leave your site with items still in their basket. 

8) Raise your prices

This point is slightly controversial. Raising your prices is definitely a way to bring in more money, but it may have some negative consequences. 

In the short term, it will increase the amount of income per customer. But then again, the higher prices might drive existing customers away and discourage new customers from choosing your business. 

This is particularly harmful to subscription-based businesses, or any business that’s well known for having low prices. 

Track your cash flow with the 2 in 1 accounting app

Figuring out solvency ratios requires detailed financial records like cash flow. And keeping financial records is simple with the Countingup app. 

Countingup is currently the only business current account that lets customers view their cash flow in real-time. This is because it combines the business current account and accounting software in one app. Other accounting software offers the ability to link to bank feeds, but there can be data lags and so this information is often not up-to-date. With the Countingup app, you’ll always have the latest, most accurate information possible. 

Alongside other features like automatic expense categorisation, invoicing on the go, receipt capture tools, and tax estimates, you can confidently keep on top of your business finances wherever you are. 

You can also share your bookkeeping with your accountant instantly without worrying about duplication errors, data lags or inaccuracies. Seamless, simple, and straightforward! 

Find out more here.

Related Resources

Read more