Credit rating is the risk evaluation of any business venture, company, or individual start-up. It is the analysis of the company’s valuation of repaying any debt or fulfilling any financial obligation. It is altogether a quantified judgment of the business and the borrower’s creditability.
Credit rating or credit scores are then assigned based on this credit rating. These scores are given to the individuals after looking into the history of lending and re-paying the taken credit. It is an important parameter to assess while getting any loan approved. Some of the well-known companies like; S&P Global, Fitch Ratings, and Moody’s issue and support private companies and public sectors. Various investors evaluate the risk using criteria like debt repayment history and buying bonds sanctioned by the companies.
What is a Rating Agency?
Rating agencies are the credit company that assesses the financial levels of private and government organizations for the capability to pay the principal and interest amounts. This rating is the gauge scale of the said company presenting its potential to pay its debt obligations in a timely manner. The agencies assign a unique letter as a means of assessing the high or low-risk financial defaults or financial solidity of the borrower. The unique letter combinations assigned are AAA (excellent) mentioned at the top, and C, or D at the bottom part. Some companies rated as junk or speculative grade are under the highest risk category.
The credit rating is issued by the selected independent nations, local and state government organizations, business corporations, non-profit establishments, or institutions assigned on special purpose. The corporations who are into the business of issuing public ratings or credit ratings are called credit rating agencies. The services of credit rating agencies are available by organisations to rate a state or nation on different parameters, to rate a company for purposes of listings and loans, to rate mutual funds or other types of issues.
Role of Credit Rating in Business Financing
Interpretations of Credit Ratings:
- A higher rating given by a rating agency is suggestive of the repaying of the debts without any difficulty.
- A low rating is suggestive that completing the payment protocols is a struggle.
- The lowest rating is assigned when the borrower is in a financial crisis.
The company bonds are credit-rated before they are issued. The interest is paid according to the credit ratings received. In such cases of high-case investments, higher rates are compensated. Both the investors and lenders evaluate the credit ratings before stepping into the business agreement compiled under the agreed terms and conditions of paying the interest rates in case of high-risk ventures.
These credit ratings given by the agencies are also within the foundation of a stipulated timeline. Credit ratings under the short-time period are likely to be debt by default within a timeline of one year for the borrower. Credit ratings dispersed in longer timelines are likely to be influenced and default at any given point in time. Some of the credit rating agencies in India that rate issues are CRISIL, CARE, BrickWork and ICRA etc. Other Credit bureaus that give credit scores to individuals / companies in India are TransUnion CIBIL, CRIF High Mark, Experian and Equifax.
Role of Credit Rating Agency
The rating agencies estimate the reliability of the various debt securities and money lending entities which are issued by various business enterprises and government set-ups. Higher credit ratings of at least two agencies are evaluated in specific cases of high monetary investments. The credit agencies are held solely responsible for any flawed and unreliable ratings.
These credit ratings have their prime importance in the case of high-end financial transactions such as mortgage financial securities, asset-secured finances, and collateral financial obligations. The rating agencies assessing the capital funding and the proposed security assets are imperative to be checked by the investors. These investors pay themselves to these agencies for giving a reliable rating to their products or set the bars accordingly.
These credit rankings help government organizations for the issuing of bonds for investments done nationally and internationally as referred by many developing countries.
Benefits of Credit Rating
There are varying benefits to the credit ratings issued by the agencies varying at different levels which are as follows:
- Banks utilize these ratings to judge the financial risk of the premiums which are charged on the bonds and loans.
- A good rating is suggestive of the fact that the borrower can easily borrow money from the financial institutions and debt market all done at a lower interest rate.
- A low rating is suggestive of the high premiums associated with higher risks, this leads to increased interest rates to be paid by the individual on the loaned amount.
- Corporate businesses also refer to these rating agencies for checking upon the creditability of the securities of the companies for rating the debts. These ratings decide the nature and timeline of investments.
- These credit ratings are the financial data given by international agencies in terms of their accuracy and dependability. The ratings shared by these agencies are not publicly available information as it is also provided by underwriters and financial agencies.
- Credit ratings at the country level are much appreciated for the right investment decisions. It helps in attracting high-value clients for higher investment purposes by getting to know the high credit ratings of the agencies. This helps in even achieving foreign direct investments in the country.
- Credit rating helps in easing out financial decisions by providing a comprehensive study of the national and international market without having to go through any tedious evaluations.
- The ratings formulate as a basis for the financial market investment schemes and business operations.
Limitations of Credit Rating
Credit ratings may be an essential factor to be evaluated but not a mandatory requirement as the only reliability.
Ratings are error-prone.
Credit ratings are not accurate enough to mark themselves as the only reliable parameter for financial assessments. It is required to analyze the provided data with previous and current facts and figures supplementing it. Criticism of credit ratings has already been received in the global financial crisis statistics of 2008-2009. Hence, it is required to self-update with your research on credit ratings by credit agencies.
Ratings are independent of market scenarios.
Credit ratings are independent of market conditions, such as investment portfolios, interest rates, economic conditions, financial debts, and any risks associated with them.
Ratings are based on past analysis.
Credit ratings are a framework of past ratings not a database of present and future financial figures. There may be still financial hardships even with a strong credit rating due to changes in any industry and market trend.
Ratings do not elaborate on risks.
The credit ratings involve the right information to make the said choice regarding your investments but not about the financial risks involved. So, it is imperative to get your charts right with your careful evaluation and identification of all the risks involved.
Credit ratings are just a reference.
Credit ratings are a type of subjective vision issued by different agencies. There are different criteria assessed and analyzed before issuing the rating as there is creditworthiness associated with the rating of credit to prove its worth.
Steps to Improve Credit Score for Better Loan Terms
- Make Timely Interest Payments – this will help maintain and increase the credit rating and also build good business relations with the banker.
- Debt Consolidation – Consider consolidation or refinancing to avail better interests that in turn lowers interest burden and increases credit score.
- Improved Relations with your Banker – Negotiate and communicate any discrepancy, delay, or unfavourable terms so as to keep your loan and business free from any restrictive covenants, and negotiate better interest terms.
- Timely submission of all Documents – Keeping an eye on the banking calendar is equally important. Submitting your CMA data report, debtors report etc. are crucial for the ongoing loans and also paves way for better loan terms in future.
- Maintain Low Credit Utilization – Monitoring credit utilisation and using credit strategically goes a long way in maintaining a healthy credit score.
- Seek Professional Help – Consider consulting a banking advisor like BankKeeping, who can be your guide through the banking journey starting from reducing credit, maintaining a timeline for regular submissions, interest reduction and more loans on the same collateral.
Conclusion
Credit ratings are the retributions given by private and government agencies to potentially risky financial investments. It just acts as a blueprint assigned to the business owners, corporations, and investors to strategize as per the rating. The importance of the credit rating is not a guarantee but a means of showing the credibility of the business that seeks funding. It is like a security check done by the lending institutions to assess risk of lending to the said organisation.
Many banks conduct their own internal credit rating check to evaluate the lending risk. Based on the final internal rating score, the Banks thereafter decide as to how much loan can be given and at what terms, how much collateral need to be taken from the borrower, can any concession be offered in interest rates, what are the covenants to be imposed, and so on. Hence the company needs to focus on improving its credit score to get favourable terms on its Business loan. Having said this, always remember that these ratings may be a stepping stone but there is a lot that has to be done to avail a loan and service it well. BankKeeping can be your guide through the cumbersome process of applying and servicing your loans, along with negotiating terms and conditions based on the Bank Sanction Letter.