Household solvency is a measure of how well you are able to pay your bills and other financial obligations, both short- and long-term. It is a calculation of your overall financial health. Solvency is determined by an examination of your ratio of assets to liabilities, and taking into consideration factors such as liquidity, or how easily you can get cash. Achieving solvency equals financial security for you and your family.
TL;DR (Too Long; Didn't Read)
You're financially solvent when you can pay for your liabilities for the long term.
Consider Your Owned 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, liquid assets are a factor because these determine how quickly you can access cash. Liquidity is the availability of assets that are cash, or assets that are easily convertible into cash. You need liquidity in order to meet financial obligations. Examples of liquid assets besides cash include market securities, treasury bills and accounts receivable.
Look at Your Liabilities Owed
Liabilities are what you owe to creditors. A Visa bill of $8,000 is counted as a liability. Money owed for income and property taxes, and 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 paid out over a longer period. Your annual income taxes are an example of a current liability. A mortgage or a college loan paid back over many years is a long-term liability.
The liabilities you owe changes regularly, so make sure you keep tabs on your liabilities. If you are a co-signer on another's note or obligation, this should be included in liabilities, in case that person cannot pay down the debt.
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.
You want to have more cash coming in than cash going out. Fiscal health is important no matter what stage of life you are in. Your ratio of debt to equity is this: Total all your debts shown on your balance sheet, and divide by your net worth. Your goal should be 80 percent or less.
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.