PADM 702 LIBETY UNIVERSITY Solvency Analysis _2024.pdf

Solvency Analysis

PADM702: Public Budgeting

Dr. Samuel Clovis

April 21, 2024

The Degree of Solvency of Bay City, Texas

Solvency ratios are often used as a way for entities to measure if metrics are being met

and keep track of the long-term financial goals. Ratios assist in determining the financial health

1.00

Current Ratio

The chart shows the current ratio at 2.63 for the fiscal year of 2022 or FY22. The

minimum requirement to meet debt goals is 1.00. Meaning, a 2.63 for the current ratio exceeds

the threshold and provides an increased confidence to meet debt obligations and obtaining more

funding when it is needed in the possible future.

The current ratio of 2.63 is based off the city’s total in assets at $15,429,273, along with

the liabilities at $5,863,375. Having the current ratio at 2.63 is great for Bay City since it gives

them more borrowing power in the future if the need arises. There are always unforeseen

circumstances in government that bring about the need for more money, making it hard for city

leaders to accurately plan beforehand, and important for them to have borrowing power.

Furthermore, city leaders must also find ways to pay back money borrowed in times of need.

total amount in expenses to the total amount of revenue to understand how well the budget was

kept and how it worked. The FY22 total revenue for Bay City was $30,990,500. The FY22 total

expenses for Bay City was also $30,990,500. This makes the operating ratio at 1.00 for FY22.

This is the minimum on the threshold before crossing into red and not breaking even (Hayes,

If this was a regular company, this ratio would mean the company “broke even” and did

not turn a profit for the year (Sintha, 2020). However, a government entity is not a traditional

corporation, so Bay City is safe with a 1.00 operating ratio. However, if it is possible to improve

the operating ratio, Bay City would be wise to do so. An improved operating ratio would

significantly lessen the chances of liability for Bay City since it would create an excess in funds

at the end of the FY that could be used to cover emergencies without creating additional debt.

Within finance, an operating ratio of 1.00 ratio is cutting it close and should be addressed

to ensure the financial health of the entity. In comparison to the previous few years of Bay City,

this ratio does not cause too much alarm since the operating budget had similar ratios in those

fiscal years. However, if Bay City was trying to improve this ratio, the outcome could be

explained by the operating budget needing to be stretched in late 2021 at the beginning of the

the Bay City area (White, 2021). Bay City does not have a city funded power company but this

Net asset ratio Bay City FY22 is the total assets stacked up against the restricted and

unrestricted assets. The total in assets is $65,815,497 for Bay City FY22. The unrestricted and

restricted assets for Bay City FY22 equal $34,718,039. Again, 1.00 is the minimum that needs to

be met in order to break even for Bay City. However, the goal should be for a better ratio since

Bay City had a net asset ratio of 1.90 for FY22, meaning almost double the held assets

for the year. This ratio gives Bay City decent capability to confidently manage debt and

liabilities. It also shows good standing for Bay City in the area of having a surplus to pull from in

the future. Lastly, it showcases Bay City being in good financial health for assets in FY22.

However, the net asset ratio is not necessarily important as long as it is over 1.00. this is because

Comparison of Ratios

Each of the ratios discussed above is different from one another. While ratios are always

a comparison of some sort, different ratios calculate different comparisons. The current ratio is

showcasing income versus expenses for FY22. This is most important ratio for Bay City since it

shows the ability to sustain without increasing debt (You, 2024). The operating ratio is the

second most important in the line up since an inefficient operating budget could disrupt Bay

Bay City to take on debt. The net asset ratio, while important, is sufficient as long as it is at a

1.00 or higher.

When looking at the three different categories, on the chart, the following can be

concluded:

I. The current ratio stands at a healthy 2.63 and that implies that Bay City should not

that the operating budget expenditure for FY22 was not efficient enough to meet

the optimal financial long-term goals of Bay City. Bay City should be concerned

plan for the operating budget of FY23. After an analysis is done on the operating

ratio of FY22, it can be reviewed, and a plan can be made for the next fiscal year.

III. The net asset ratio for FY22 stands at 1.90 for Bay City. While this ratio could be

improved, it is a strong proportion that Bay City should not be concerned about.

how to further increase this ratio if possible. If not, the focus should be on

Bay City, like many other towns have dreams of improving the community for the residents and

for Bay City.). With such monumental plans, it is important for Bay City to focus on improving

solvency each fiscal year.

Solvency

Solvency is an entity’s ability to meet long-term financial obligations by having more in assets

than liabilities (Horobeț et al., 2021). Solvency is used in finance to determine if debt can be paid

off, while not jeopardizing if other financial responsibility can be met long-term. Solvency is

calculated through using ratios. The minimum ratio threshold 1.00 which would be the same as 1

to 1 ratio for the given category. Solvency is an important tool that people within the field of

finance need to understand and use to be able to make informed decisions that greatly impact

Solvency Decreases Risk

An entity being solvent means that its current assets outweigh its liabilities, which ensures that

financial obligations can be met (Coulon, 2020, pt. 3.3). Lenders would only want to loan to a

solvent borrower since this is less risky when it comes to repayment. Not all solvency methods

are the same, however. One of the most common solvency methods includes debt to equity ratio

which helps to pinpoint the organization’s financial leverage (Horobeț et al., 2021). Another

could be.

Solvency has many advantages when it comes to ensuring financial wellbeing long term. There

are also specific advantages that make using it efficient for entities like Bay City. One example

of an advantage to using solvency to measure financial risks lies in how solvency ratio helps to

simplify planning for unexpected emergencies (Gatzert & Heidinger, 2020, p. 415). While most

budgets do not and cannot plan for unforeseen emergencies and economic challenges, using

solvency ratios when creating metrics helps to ensure there is room for unknown downturns

since it raises the standard for what acceptable financial stability is. Furthermore, it also ensures

that long-term goal setting is made and maintained (Solvency: What Is It and How to Calculate |

QuickBooks, 2023).

Disadvantages of Solvency

Solvency has advantages as stated above, as well as disadvantages. It is normal for any

approach to have disadvantages, however. One disadvantage of solvency is the stress it can put

on a budget’s cash flow due to needing to obtain and stay at a certain level of solvency (Horobeț

et al., 2021). While solvency helps to improve conditions for emergencies, it does not allow for

unforeseen opportunities to be taken. This is even if the opportunities could be great chances for

the company. Again, solvency is about reaching longer term financial goals and can keep the

spender in a decently strict spending environment.

Another disadvantage is that when using solvency ratios, measurements must be

interpreted in an overall analysis to truly be helpful. The ratios themselves do give insight into

would need to be presented alongside the ratios. Without an analysis, the ratios could be

confusing to the long term financial goals. Other financial ratios do not always need analysis

Liquidity measures how easily an asset of an entity can be bought or sold in a market

without losing too much of the value while for sale (FreshBooks, 2023). Meaning, a highly liquid

asset would easily sell without the seller having to lower the price by too much to gather buyer

grocery store or essentially anywhere else where things are sold. Liquidity helps to determine

what the value of assets are, therefore helping sellers to know how to categorize them price wise.

Solvency vs Liquidity

about. In one light, liquidity helps determine the short-term goals and the ability to pay off

current debt. In another light, solvency helps to measure financial stability and overall financial

health for long term goals. Both liquidity and solvency are imperative for entities to utilize for a

healthy financial environment, but liquidity focuses on short-range fiscal flexibility, while

solvency helps ensure stability for the long-term goals (Coulon, 2020, pt. 3.1).

is a great tool for organizations to use to be able to afford opportunities that are not in the budget,

to repay debt in a flexible way, and to ensure short-term financial stability. Bay City, Texas FY22

shows good solvency ratios for two out of three categories, and this increases Bay City's

borrowing power and chances of long-term financial stability. Bay City has an immense and

vivid plan for the future of the town, inclusive of attracting tourists, building a better community,

and ensuring that residents have a say in the future of the town. It is important that Bay City

continue to improve the fiscal expenditures to increase the overall solvency of the town. The

surplus from each fiscal year can be used to make the Bay City vision board become reality.