Ways to Check the Credibility of a Company
Companies with higher credit ratings will be seen as lower risks and hence they get loan applications approved more easily than other companies.
A credit rating can act as a deciding factor that helps borrowers in making decisions whether to buy or not to buy a loan from that particular organization. In the case of the stock market, a credit rating allows investors to make an important decision regarding the performance of a company.
There are certain agencies that evaluate the risk tolerance of a company. In other words, the credit rating provided by these agencies assists in making a correlation between risk and return tradeoff of an instrument.
To accomplish the whole process, they come up with a tool that helps analysts to measure the risk of any debt instruments and assess if the returns are performing well against the risks.
How Do Investors Benefit From Credit Rating?
A company's credit rating is an important consideration when choosing a company's stock to indicate its position in the market, and its credit rating indicates that a particular company is possible, so a credit rating is.
It is a useful source of information for investors. Repay the agreed loan amount without any problems. Poor credit ratings, on the other hand, indicate that the company may have a hard time paying off the full loan.
This allows investors to make appropriate decisions when choosing a company's stock. If a company fails to repay a loan, it is given the image that the company does not have enough cash to repay its debt and the stock price plummets.
Rating Agency In India
A rating agency is a company that assesses a borrower's ability to repay a loan borrowed by an investor on time. Rating agencies assess the financial position of a company, state, or country and propose measures to improve future financial accountability to borrowers. The main rating agencies in India are:
Sr. No
Credit Rating Agency
Establishment Year
Objective
Functions
Rating Scale
1
CRISIL
1987
The primary objective of CRISIL is to identify the creditworthiness of the companies. The companies mainly consist of public limited companies, banks and financial institutions.
Provide ratings to the companies.
Identify the solutions for the smooth working of small and mid-term enterprises.
AAA, AA, A - Good Credit Rating
BBB, BB - Average Credit Rating
B, C, D - Low Credit Rating
2
ICRA
1991
ICRA provides guidance to the stock analysts and institutions. It also improves the transparency of the regulators such as SEBI, RBI and others.
Provides guidance and information to the individuals, institutional investors and borrowers.
The rating scale of ICRA includes long, mid and short term deposits, securities and instruments respectively.
3
CARE
1993
The CARE company prepares the report on the credit rating on credit ratings and generates research reports.
Help the corporations to generate capital for numerous requirements.
Rating based on two types of instruments - Long term instruments and short term instruments
Rating Basis
Credit Basis is the main reason a company, state, or government is given a rating. Rating agencies need to make the rationale for the rating publicly available, including a detailed investigation of the factors, the rating and the justification of risk factors.
Key Rating Drivers in Rating Basis
Gearing Ratio:
A gearing ratio is a financial ratio that compares a company's liabilities to other financial standards such as stocks and company assets. A high gearing ratio for a company indicates that the company is in a strong financial position.
Diversification of Product Composition:
Diversification of product composition refers to the complete set of products or services offered by a company. When a company trades a wide range of commodities, if the company's commodities do not make a profit, they are collected by other commodities, so the risk is limited.
Working Capital Demand Loan
Licensed to meet daily business needs. If a company can meet its short-term operational needs, it can certainly meet its obligations.
Net Interest Margin
Net interest margin is a measure of the difference between interest expense and interest income, adjusted for return on total assets. A positive net interest margin indicates that the company is operating profitably, and a negative net interest margin indicates investment inefficiency.
Net Worth
A company's net worth is calculated by subtracting total assets from total liabilities. It shows the financial condition of the company. If total liabilities exceed total assets, creditors may not be confident in the company's ability to repay loans.
Total Debt to Total Assets
It shows the amount of debt a company uses to fund its assets. The higher the ratio, the higher the volatility of profit per share due to changes in the unit of operating profit, and the higher the risk of investing in a company.
After discussing the concept of credit ratings and their key rating factors, the next blog will discuss case studies for better understanding.
Things to Ponder Before Making Investment Decisions
Needless to say, credit rating plays an important role in deciding the worthiness of a company, these ratings also have some limitations. The ratings majorly depend on subjective information and senior analysts or investment bankers’ judgment.
Hence, it is imperative to ponder certain things before investing:
- Credit ratings are measured by the past performance of a company.
- If an issuing company's pernicious intentions can hide its intention from the credit rating agency too.
- Please note that credit agencies rate an instrument and not the whole company. Therefore, it is required to check the credit of the different instruments issued by the same company.
- The rating given by these agencies might differ from one another.
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