Whether you’re an investor or a business owner, solvency is defined as having enough value in the form of your assets to cover all of your liabilities. By subtracting your liabilities from the value of your assets you calculate the amount of equity you have built up. Banks measure this by what is called your loan to value ratio (LVR). The lower your LVR or the greater your equity, the better off you are.
If your equity becomes negative you are said to be insolvent and bankruptcy may be just around the corner if you can’t generate enough cash flow income to meet your debt requirements in a timely manner.
It is important to recognise that asset values can rise and fall. Therefore monitoring the value of your assets, ensuring your LVR has a satisfactory margin and that your cash flow is sufficient to meet all your obligations are important aspects of managing against the risk of insolvency.
