What Makes You Financially Solvent?

by Rose Mathews , Demand Media
    One result of insolvency is bankruptcy.

    One result of insolvency is bankruptcy.

    The solvency of a household is a measure of how well you are able to fulfill financial obligations, both short- and long-term. It is a calculation of your overall financial health, determined by an examination of your ratio of assets to liabilities, and taking into consideration factors such as liquidity. Achieving solvency equals financial security for you and your family.

    Assets

    An asset is any item of value that your household possesses. Property, investments, cash, buildings and equipment are considered assets. Accounts receivable is also in this category -- money you are owed in salary, for example. When examining the solvency of your household, liquidity of assets is a factor because it determines how quickly you can access and leverage these assets in order to meet financial obligations. Examples of liquid assets include cash, market securities, treasury bills and accounts receivable.

    Liabilities

    Liabilities are what you owe to creditors. A Visa bill of $8,000 is counted as a liability. Money owed for property taxes or for maintenance and repairs are additional examples. "Current liabilities" are defined as those that are payable within one year's time, while "long-term liabilities" are payed out over a longer period. Your annual income taxes are an example of a current liability. A mortgage or a college loan payed back over many years is a long-term liability.

    Why Build Solvency?

    Solvency means your family is fiscally secure, able to maintain a standard of living into the future and in no danger of facing bankruptcy. Creditors evaluate your solvency to determine the likelihood that you have enough stability to pay back a loan. Insurers may want evidence of fiscal health when determining their rates. Prospective landlords take your financial solvency into account when determining whether to rent you property.

    Strategies for Building Solvency

    To build solvency, you must improve your ratio of assets to liabilities. A good start is a healthy savings account -- save 10 percent of your monthly income if possible. If your company offers a 401k, contribute the maximum amount. Cut out frivolous spending -- be honest about your income before shelling out for vacations, designer shoes and Starbucks. Explore ways of generating additional income, passive or otherwise. Avoid too much debt, particularly from high-interest loans and credit cards.

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