In the context of company law, what does ‘solvency’ refer to?

In the context of company law, ‘solvency’ primarily refers to the ability of a company to pay its debts as they fall due. This is a crucial concept because a solvent company can meet its financial obligations without needing to restructure or seek additional financing. Solvency is often assessed using both cash flow and balance sheet approaches, but fundamentally, it hinges on the company’s capability to honor its liabilities as they become due.

This is essential for creditors and stakeholders, as it provides assurance about the company's financial health and operational stability. If a company is found to be insolvent—that is, unable to pay its debts—it may face legal actions such as liquidation or bankruptcy, which can significantly affect its stakeholders.

While generating income, market value, and equity are relevant financial metrics, they do not define solvency directly. Generating income relates more to profitability, market value pertains to the equity price and investor perception, and equity measures the ownership interest in the company. However, none of these concepts directly address the immediate capacity of the company to satisfy its financial commitments. Thus, the correct understanding of solvency lies in the company's operational capacity to meet debts as they arise.