Credit rating – An invaluable tool to build a sustainable organisation
Many MSMEs treat credit rating as a ritual to satisfy the bank. In reality, it has the potential to enable building stronger and sustainable entities.
We recently came across a case in which an MSME enterprise’s credit rating was below investment grade. As a result, the bank’s loan exposure to the firm was priced slightly higher. The entrepreneur was clearly upset, and he blamed the credit rating system, which he believes is more of a burden than a virtue. He was chastising his bank for ignoring his long-term relationship.
We took up the case and analysed the inputs given to the rating agency, and we made our own assessment of the firm’s financial and business standing. We found that his grievances are not entirely out of place. The firm standing is much better than many others in that industry.
The obvious question is why the firm did not get the credit rating it deserves
The notable reason for the lower credit rating, we observed, was the poor level of accounting practice. The principles of corporate accounting are not adhered to despite having a large turnover. It is further compounded by the low level of engagement with the representatives from rating agencies while they were doing their work.
The company religiously handed over documents that were needed by the rating agency. There was no attempt from the company side to interact and provide deeper insight into the operational, managerial, financial, and industrial factors which are benign to the company and how the future would look like for the company.
This disinterested approach is emanated from the perception that the rating just a ritual to satisfy the bank that extended the loans.
Its true value was not appreciated by the company promoters. Simply they were not aware that interaction with rating agencies during the process would enable them to have better insight into their own business which the representatives of rating agencies normally discuss. Secondly, they were not aware of the multiple benefits the credit rating exercise will bring.
The benefits of Credit Rating:
- Diversify the funding base and lower the interest cost: A good rating can help you gain faster and cheaper credit for your venture. The firm’s rating visible to the general public online may prompt structured debt providers to approach directly with better structures at competitive rates. A good rating can trigger an appetite for investors to join hands.
- Expanded business opportunities: The independent risk evaluation of SMEs by an unbiased third party lends credibility to them and opens doors for them while dealing with MNCs and corporates. They can submit credit ratings for tenders and make you more credible to get bigger orders. It is a fact that better ratings have helped the SMEs retain customers and suppliers, and negotiate better terms with them.
- Risk Mitigation and self-improvement: Credit rating is a third-party assignment and the work needs to adhere to certain regulations. They normally do their job in an unbiased way. Further having been in this exercise, they do advise on improving the internal controls, better adherence to accounting standards, and suggest ways to improve the governance. It emphasises the strengths and weaknesses act as triggers for self-correction. Regular renewal of ratings not only helps improve a firm’s performance but also internal control.
- Better-rated entities will enjoy a higher reputation: Another advantage is a higher reputation. It has the potential to embellish the reputation in the market. Disclosure of the rating of the firm by credit rating agencies is mandatory and being published in the press briefing and rating agencies website. This is easily amenable to the general public to view. Having been rated well means positive vibes will spread about the company. A firm that received a better rating has an obvious chance of receiving good review and enhanced confidence for those who would like to engage in the business with it.
Sustainable Organisation and rating:
Every entrepreneur aspires to make his organisation lasting longer. They strive hard, sacrifice a lot of privileges, passionately pursue their mission, and put at risk everything they possess.
However, no organisation can claim stability in the face of a fast-changing business environment and disruptions imposed by multiple factors.
The rating can help the organizations in two ways:
- It will help to eliminate the risks by exposing bad practices in the annual rating exercise.
- The organisation’s which aspire for better rating will obviously improve its governance, compliance and control mechanism and thereby build encumbrance.
Credit rating is a statutory obligation for those who have availed a significant amount of debt from the bank. In reality, it is a potential tool to elevate the standing in the minds of customers, suppliers, potential employees, potential investors & debt providers, and other stakeholders including larger society.
Every organisation- small or big, having a bank loan or not- should take credit rating like a serious exercise and strive to secure a superior rating. Those who are rated lower must strive to improve the rating by working in the weak areas.
Author: Anil Kumar Shetty, Founder SME Advisors