4 Major Risk Parameters Used By Credit Rating Agencies To Evaluate The Financial Status Of A Company

Have you ever wondered how different companies manage their financial services? Where do the start-ups get the money from to get their business started? In most of the cases, they talk to reliable investors and persuade them to invest money for their business to kick-start. Now the question is how the investors figure out which company to invest their money in. That is when the role of credit rating agencies comes into play.

What Exactly Are Credit Rating Agencies?

Credit Rating Agencies or CRA rates the financial services of different companies all over the world. These agencies analyse certain risk parameters to assess the financial services offered by the companies. Then they help the retail investors make the right decision by breaking down the financial status of the company. The agencies check whether the bonds, fixed-income securities and other debt instruments of the company will be able to meet the investor’s obligations or not.

There are three main credit rating agencies in the UK such as Moody’s Investor’s Services, Fitch and Standard & Poor’s. The rating scale starts from the letters AAA and goes down to C. A company is termed as ‘junk’ if its rating is below C.

Now that you know how does a credit rating agency works, let’s check out the parameters they follow to rate a company. Companies can take care of all the parameters to maintain a standard rating for investors to trust them.

Top 4 Risk Parameters Followed By Credit Rating Agencies

CRAs use the following risk parameters to evaluate the financial status of a company. Then they guide the investors accordingly. Check out the risks to ensure your company plays by the rule book of credit rating agencies.

1. Financial risk

This one emphasises more on a company’s debt servicing ability. It also includes a thorough assessment of the sufficiency and sustainability of the company’s cash flows. CRAs will also assess the business strengths of a company and how the strength impacts its current and future financial performance.

CRA is most likely to rate a company high if it has financial flexibility. Thus, in that case, investors can go ahead and invest in that particular financial company.

2. Business risk

No matter what your nature of business is, every company goes through cash-crunch time. The business risk parameter takes the company’s cash flow stability into account during those times. CRA will analyse the business fundamentals of the company, market position in the industry and the operational efficiencies of the company.

If all the factors mentioned above are fine, credit rating agencies will rate the company okay. But, if there's a down spin in the company or if the market position changed abruptly, that might affect the ratings.

3. Management risk

This factor takes the company’s management philosophies, risk appetite and strategies into consideration. The credit rating agencies also evaluate the management’s experience along with its track record. The credit ratings will decrease to a great extent if a company has higher risk appetites.

Thus, every company should take care of its management policies. Investors are most likely to invest in the fixed deposit schemes or debentures if the management policies of the company are reliable enough.

4. Project risk

Credit rating agencies will check out this factor if the company needs money to launch a new project. CRA will evaluate the final output and other beneficiary aspects of that project to rate the company right. At times, the new projects do not work out. The ratings from CRA will make it easier for investors to stay abreast of the risks associated with investing in the new projects of a particular company.

The thing is that there are risk-free projects since there are innumerable things that can have a negative impact on the projects. Therefore, it is crucial for companies to identify the loopholes in the project and come up with ways to manage them for higher credit ratings.

Wrapping Up,

These are the most common types of risk parameters that the credit rating agencies usually consider to evaluate the financial status of companies. Credit ratings apply to government and businesses. The better the credit ratings, the easier it is to borrow money from investors.