| ||Solvency is one of the key measures when it comes to measuring farm financial management.
“Financial risk can be broken down into three main financial management parameters- solvency, liquidity, and profitability,” says Rick Dehod, agricultural farm finance specialist, Alberta Agriculture and Forestry. “Once the measure within each of these three financial parameters has been assessed, the overall financial health and exposure to financial risk in a farming operation can be determined.”
Solvency is defined as having enough value in the form of assets in a business to cover all of its liabilities. “Solvency is based on the accounting equation that assets equal liabilities plus equity. A business with positive equity is said to be solvent. When a businesses’ equity becomes negative it’s said to be insolvent. Bankruptcy is just around the corner for an insolvent business if it doesn’t generate enough cash flow income to meet its debt requirements in a timely manner.”
Solvency is measured by the relationship among the assets, liabilities and equity of a business. “By subtracting liabilities from assets you calculate the amount of equity in a business. The larger the number is for the equity amount the more financial secure the business is. But everything is relative. Larger businesses need more equity to remain viable than smaller businesses do.”
Solvency ratios depend on the type of farm enterprise. “Supply managed industries can carry higher financial risk and survive in the long-term as their income is secure and frequent. Thus, they have less profitability risk, and can carry greater solvency risk.
“Solvency provides your farm with the ability to absorb risk and stay in business in the lean years. A farm with strong equity can absorb and loss and continue to operate. A farm that has leveraged its equity through debt can provide greater returns on equity when times are good but can quickly be at risk when the farm runs into difficulties. Knowing your solvency and your farm’s ability to manage risk will provide you with the information to manage your business and protect or grow your equity.”
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