Solvency of a business is best indicated by the value of the firm's:

• A. Net worth
• B. Total assets
• C. Cash flow
• D. Profitability

Answer: (A)

Solvency is about the long-term ability of a business to meet its debts. The best indicator is net worth, which is assets minus liabilities. When net worth is positive, the firm has more assets than debts, meaning there’s a cushion to cover obligations even if earnings dip or asset values fluctuate. If net worth is negative, liabilities exceed assets, signaling insolvency risk regardless of short-term cash flow or current profits.

Total assets don’t reveal how big the debt burden is, so they don’t directly show solvency. Cash flow shows the ability to pay bills in the near term but can be volatile and doesn’t prove the long-term balance between assets and liabilities. Profitability measures earnings, but a business can be profitable yet still have too much debt relative to assets to be solvent.