Ever asked yourself:
- Why do I feel short of money even though my sales are decent?
- My profits look okay—so why did the bank reject my loan?
- What’s the real difference between solvency and liquidity?
- Which financial numbers should I check every month?
If these questions sound familiar, you’re in the right place.
For many small business owners, financial terms like “liquidity” and “solvency” can feel overwhelming. The good news is—you don’t need a finance degree to understand them.
This guide will explain everything with relatable examples and step-by-step tips. You’ll learn how to track your business health using simple tools, avoid cash crunches, and make smart money decisions. We’ll explain solvency vs liquidity in small business, using simple language, everyday examples, and tips you can apply right away.
By the end, you’ll feel more confident, in control, and ready to run your business smarter.
What Is the Difference Between Solvency and Liquidity?
Solvency
Solvency measures a business’s ability to meet its long-term financial obligations.
It tells you whether your business can survive in the long run—even if market conditions change. Solvency helps assess whether your debt levels are sustainable and if you’re building a stable financial foundation.
Liquidity
Liquidity reflects a business’s ability to meet short-term obligations using current or liquid assets.
It shows how quickly you can pay monthly bills like rent, wages, or suppliers. Liquidity ensures you can operate smoothly day-to-day without delays or cash stress.
Let’s say you run a small mobile repair shop in Ranchi. You took a 3-year loan to buy new tools. Solvency tells us if you can keep the shop open for the next 3 years. Liquidity tells us if you have enough money this week to pay your technician and buy spare parts.
Both matter. If you ignore either one, your business could suffer.
Why Should Indian Small Business Owners Track These?
Whether you’re a tuition teacher in Bhopal or run a home bakery in Surat, knowing your solvency and liquidity status helps you:
- Avoid sudden cash crunches
- Build trust with banks and investors
- Make better loan and spending decisions
Understanding business solvency and liquidity is not just finance talk—it’s the difference between surviving a slow season or shutting down.
Liquidity Ratios: Can You Pay Your Bills on Time?
Liquidity ratios help you measure your ability to cover short-term expenses—like wages, utility bills, or supplier dues.
Current Ratio
The current ratio compares your current assets to your current liabilities.
It shows if your business has enough short-term assets to cover upcoming payments. A current ratio above 1 suggests that your business can handle day-to-day operations without financial stress.
Formula: Current Ratio = Current Assets / Current Liabilities
It shows how much money or near-cash assets you have for every ₹1 you owe soon.
Example: A tuition teacher in Kolkata has ₹60,000 in hand and bills worth ₹20,000.
Current Ratio = ₹60,000 / ₹20,000 = 3.0
She’s in a strong liquidity position.
Quick Ratio (Acid-Test Ratio)
The quick ratio is a stricter version of the current ratio that excludes inventory.
Not all assets are easy to convert to cash; this ratio gives a more realistic view of immediate liquidity. A better understanding of how fast your business can meet urgent financial needs without depending on stock sales.
Formula: Quick Ratio = (Cash + Bank + Receivables) / Current Liabilities
This excludes inventory because unsold stock might not convert to cash quickly.
Example: A mobile shop in Ahmedabad has:
- ₹25,000 in bank
- ₹15,000 in customer dues
- ₹10,000 in spare parts
- ₹20,000 in monthly expenses
Quick Ratio = (₹25,000 + ₹15,000) / ₹20,000 = 2.0
Inventory is not liquid. You may not be able to sell it instantly.
Days Sales Outstanding (DSO)
DSO measures the average number of days it takes for your customers to pay invoices.
Knowing your collection timeline helps plan cash flow more accurately. A lower DSO means faster payments and better liquidity; a high DSO signals delayed collections and potential cash issues.
Formula: DSO = (Receivables / Credit Sales) × Days
DSO tells how long customers take to pay you after you bill them.
Example: A graphic designer in Bengaluru has ₹45,000 in unpaid bills for ₹90,000 sales this month.
DSO = (₹45,000 / ₹90,000) × 30 = 15 days
That’s a healthy collection cycle.
Many Indian clients delay payments. If your DSO is too high, your cash flow suffers—even if your sales look strong.
Offer small discounts for early payments to boost liquidity.
Solvency Ratios: Will Your Business Survive the Long Run?
Solvency ratios show if your business can meet its long-term obligations.
Debt-to-Equity (D/E) Ratio
This ratio compares total borrowed funds to the owner’s equity.
It helps you understand how reliant your business is on loans. A lower ratio indicates financial stability and lower risk to lenders and investors.
Formula: Debt-to-Equity = Total Debt / Total Equity
It tells you how much of your business is funded by loans vs. your own investment.
Example: A welding shop in Nagpur has borrowed ₹5 lakh and invested ₹2 lakh himself.
D/E = ₹5 lakh / ₹2 lakh = 2.5 (high risk)
Debt-to-Assets Ratio
This measures the percentage of assets financed by debt. It shows how much of your business assets are tied to loans.
A lower value indicates that more of your assets are owned outright rather than borrowed.
Formula: Debt-to-Assets = Total Debt / Total Assets
It shows what part of your business is financed by loans.
Example: A salon in Jaipur has ₹8 lakh in assets and ₹2 lakh in loans.
Debt-to-Assets = ₹2 lakh / ₹8 lakh = 0.25 (good solvency)
Interest Coverage Ratio
This shows how easily your business can pay its interest expenses from operating profits. Banks and investors check this to ensure you can meet your EMI obligations.
A higher ratio indicates more breathing room to handle interest payments—even during slow months.
Formula: Interest Coverage = Operating Income / Interest Expense
Shows how easily your earnings cover your loan interest.
Example: A textile trader in Surat earns ₹1.2 lakh/month and pays ₹10,000 in interest.
Interest Coverage = ₹1.2 lakh / ₹10,000 = 12 (very comfortable)
A D/E ratio above 2 may make banks think twice about lending more.
Some MSME loans in India require a healthy interest coverage ratio—not just past profit.
Example: Speedy Mobiles vs Sharma Engineering
Speedy Mobiles – Indore
- Strong liquidity: Quick ratio 2.17
- Moderate solvency risk: D/E ratio 1.25
Sharma Engineering – Ludhiana
- Weak liquidity: Quick ratio 0.25
- Excellent solvency: D/E ratio 0.16
Speedy Mobiles can manage daily expenses well but should reduce long-term loans. Sharma Engineering is stable long-term but needs urgent help with cash flow.
What Happens When You Ignore Solvency or Liquidity?
During COVID-19, many Indian tuition centres couldn’t pay rent or staff—not due to low profit, but lack of liquid cash.
Imagine a Mumbai cafe chain that borrowed ₹5 crore to expand but couldn’t recover the investment. Even though they had assets, their EMI burden was too high. That’s insolvency.
Tips to Stay Financially Healthy
- Keep 3–6 months of expenses in cash
- Track liquidity and solvency every month
- Collect payments faster (offer early-payment incentives)
- Don’t confuse stock or receivables with actual cash
- Use simple Excel sheets to calculate key financial ratios
- Check MSME schemes like CGTMSE for credit support
Conclusion
Understanding the difference between solvency and liquidity is not just about passing exams—it’s about keeping your business alive and thriving.
Whether you’re baking cakes from home or selling mobile accessories online, financial health is your safety net. These simple ratios and tips help you:
- Make smarter business decisions
- Stay prepared during lean seasons
- Build trust with banks and investors
You don’t need to master all of finance overnight. Just track the basics monthly, ask questions when in doubt, and stay financially curious. Your business deserves to grow—with confidence.
