Credit Rating

Credit Rating

In today's world there will be very few people in the business community who won't have heard of the term Credit Rating. Indeed many businesses will not enter into contracts with other bodies whether they be large corporations or individuals unless they have a suitable credit rating.

Prior to today's up-to-date accessibility of information, financial as well as technical, credit tended to be given on information possibly gained by hearsay as opposed to actual knowledge, or if collateral could be provided. This is still the case in such instances as mortgages whether they are 1st, 2nd or even 3rd mortgages where the actual deeds of your house or business are used to guarantee either credit advances or purchase of goods.

Up-to-date information technology allows us to be a lot more accurate in the assigning of a credit rating, at least for businesses. The Bank of England undertook the UK's most comprehensive econometric study of Corporate Failure. The results were published in Working Paper 210 in 2003. This paper examined the determinants of failure among individual UK public and private companies, over the period from 1991 to 2001.

Using information on:

• Profitability
• Interest Cover
• Capital Gearing
• Liquidity
• Company Size
• Industry
• Whether a firm is a subsidiary
• Overall economic conditions

it concluded that it is possible to construct estimates of the probability of failure for individual companies. These statistics are then formulated into a credit rating by the various credit rating companies. As the firms all have slightly different ways of producing their credit scores the actual numbers assigned mean very little, i.e. a score of 60 out of 100 may be average for one credit rating company but good for another. It is the definition of these scores that are the point of the matter.

From these scores and obviously depending on the size and assets of a business a suggested credit limit or sometimes various suggested credit limits can also be given. This again varies from one credit rating company to the next and all are very careful to inform you that these ratings and credit limits are not definitive and are there only as suggestions, and for guidance.

While there is not as much public information on individuals as on businesses, a similar process using all available information such as:

• Income
• Expenditure
• Current Liabilities
• Previous payment history

can be used to provide an individual credit rating. Much of this information has to be gathered either from or with the permission of the individual concerned and is therefore subject to omission of information either deliberate or accidental. This is the reason, along with lack of "wish to check information", that many individuals can obtain credit way beyond their means to repay.

Many businesses and individuals are unhappy with their credit rating and want them changed. The credit rating companies will always be willing to check their information as errors can occur, and there are many ways in which individuals and businesses can improve their credit rating. This, of course, has spawned another type of company which will look into all the details of your credit rating and come up with suggestions on how this can be improved, generally at a price.

Credit rating is a great benefit to the many small businesses and individuals who have neither the time nor resources to perform this service for themselves, and, if used as a guide, can be a superb business tool.