Valuation Reserve

Definition of 'Valuation Reserve'

The funds set aside by life insurers as required by state law to compensate for declines in the value of investment instruments that are held by the insurance company as assets. Valuation reserves are required because life insurance contracts can be in effect for long periods of time, and the securities valuation reserve is intended to protect the company's loss reserves in the event that the insurer's investments are underperforming.

Investopedia explains 'Valuation Reserve'

Prior to 1992, the mandatory securities valuation reserve (MSVR) required a liability reserve to be maintained by the National Association of Insurance Commissioners (NAIC) to protect against value changes in an insurance company's securities investments. Following 1992, the requirements set forth by the MSVR were transferred into the asset valuation reserve.

Contingent Liability
Definition of 'Contingent Liability'
A potential obligation that may be incurred depending on the outcome of a future event. A contingent liability is one where the outcome of an existing situation is uncertain, and this uncertainty will be resolved by a future event. A contingent liability is recorded in the books of accounts only if the contingency is probable and the amount of the liability can be estimated.

Investopedia explains 'Contingent Liability'

Outstanding lawsuits and product warranties are common examples of contingent liabilities. For example, a company may be facing a lawsuit from a rival firm for patent infringement. If the company's legal department thinks that the rival firm has a strong case, and the company estimates that the damages payable if the rival firm wins the case are $2 million, it would book a contingent liability of this amount on its balance sheet. If, on the other hand, the company's legal department is of the opinion that the lawsuit is frivolous and very unlikely to be won by the rival company, no contingent liability would be necessary.

Capital Reserve
Definition of 'Capital Reserve'
A type of account on a municipality's or company's balance sheet that is reserved for long-term capital investment projects or any other large and anticipated expense(s) that will be incurred in the future. This type of reserve fund is set aside to ensure that the company or municipality has adequate funding to at least partially finance the project.

Investopedia explains 'Capital Reserve'

Contributions to the capital reserve account can be made from government subsidies, donated funds, or can be set aside from the firm's or municipality's regular revenuegenerating operations. Once recorded on the reporting entity's balance sheet, these funds are only to be spent on the capital expenditure projects for which they were initially intended, excluding any unforeseen circumstances.

Profitability Ratios
Definition of 'Profitability Ratios'
A class of financial metrics that are used to assess a business's ability to generate earnings as compared to its expenses and other relevant costs incurred during a specific period of time. For most of these ratios, having a higher value relative to a competitor's ratio or the same ratio from a previous period is indicative that the company is doing well.

Investopedia explains 'Profitability Ratios'

Some examples of profitability ratios are profit margin, return on assets and return on equity. It is important to note that a little bit of background knowledge is necessary in order to make relevant comparisons when analyzing these ratios. For instance, some industries experience seasonality in their operations. The retail industry, for example, typically experiences higher revenues and earnings for the Christmas season. Therefore, it would not be too useful to compare a retailer's fourthquarter profit margin with its first-quarter profit margin. On the other hand, comparing a retailer's fourth-quarter profit margin with the profit margin from the same period a year before would be far more informative.

Solvency Ratio
Definition of 'Solvency Ratio'
A key metric used to measure an enterprises ability to meet its debt and other obligations. The solvency ratio indicates whether a companys cash flow is sufficient to meet its short-term and long-term liabilities. The lower a company's solvency ratio, the greater the probability that it will default on its debt obligations. The measure is usually calculated as follows:

Investopedia explains 'Solvency Ratio'

Solvency ratio, with regard to an insurance company, means the size of its capital relative to the premiums written, and measures the risk an insurer faces of claims it cannot cover. The solvency ratio is only one of the metrics used to determine whether a company can stay solvent. Other solvency ratios include debt to equity, total debt to total assets, and interest coverage ratios. However, the solvency ratio is a comprehensive measure of solvency, as it measures cash flow rather than net income by including depreciation to assess a companys capacity to stay afloat. It measures this cash flow capacity in relation to all liabilities, rather than only debt. Apart from debt and borrowings, other liabilities include shortterm ones such as accounts payable and long-term ones such as capital lease and pension plan obligations. Measuring cash flow rather than net income is a better determinant of solvency, especially for companies that incur large amounts of depreciation for their assets but have low levels of actual profitability. Similarly, assessing a companys ability to meet all its obligations rather than debt alone provides a more accurate picture of solvency. A company may have a low debt amount, but if its cash management practices are poor and accounts payable is surging as a result, its solvency position may not be as solid as would be indicated by measures that include only debt. A companys solvency ratio should also be compared with its competitors in the s ame industry rather than viewed in isolation. For example, companies in debt-heavy industries like utilities and pipelines may have lower solvency ratios than those in sectors such as technology. To make an apples-to-apples comparison, the solvency ratio should be compared for all utility companies, for example, to get a true picture of relative solvency.

Debt Ratio/ Capitalisation Ratio

Definition of 'Debt Ratio'
A financial ratio that measures the extent of a companys or consumers leverage. The debt ratio is defined as the ratio of total debt to total assets, expressed in percentage, and can be interpreted as the proportion of a companys assets that are financed by debt.

The higher this ratio, the more leveraged the company and the greater its financial risk. Debt ratios vary widely across industries, with capital-intensive businesses such as utilities and pipelines having much higher debt ratios than other industries like technology. In the consumer lending and mortgage businesses, debt ratio is defined as the ratio of total debt service obligations to gross annual income.

Investopedia explains 'Debt Ratio'

A company with total assets of $100 million and total debt of $30 million has a debt ratio of 30%. Is this company in a better financial situation than one with a debt ratio of 40%? It depends on the industry in which the companies operate. A debt ratio of 30% may be too high for a company that operates in a sector where cash flows are volatile and its peers have little debt, since this debt level may reduce its financial flexibility and competitive advantage. Conversely, a debt level of 40% may be easily manageable for a company in a sector such as utilities, where cash flows are stable and higher debt ratios are the norm. A debt ratio of greater than 1 indicates that a company has more debt than assets. Meanwhile, a debt ratio of less than 1 indicates that a company has more assets than debt. Used in conjunction with other measures of financial health, the debt ratio can help investors determine a company's risk level. In the consumer lending and mortgages business, two common debt ratios used to assess a borrowers ability to repay a loan or mortgage are the gross debt service ratio and the total debt service ratio. The gross debt ratio is defined as the ratio of monthly housing costs (including mortgage payments, home insurance and property costs) to monthly income, while the total debt service ratio is the ratio of monthly housing costs plus other debt such as car payments and credit card borrowings to monthly income. Acceptable levels of the total debt service ratio, in percentage terms, range from the mid-30s to the low-40s.

Activity Ratios
Definition of 'Activity Ratios'
Accounting ratios that measure a firm's ability to convert different accounts within its balance sheets into cash or sales. Activity ratios are used to measure the relative efficiency of a firm based on its use of its assets, leverage or other such balance sheet items. These ratios are important in determining whether a company's management is doing a good enough job of generating revenues, cash, etc. from its resources.

Investopedia explains 'Activity Ratios'

Companies will typically try to turn their production into cash or sales as fast as possible because this will generally lead to higher revenues. Such ratios are frequently used when performing fundamental analysis on different companies. The total assets turnover ratio and inventory turnover ratio are two popular examples of activity ratios used widely across most industries.