WHAT ARE CREDIT RATINGS?
Now days every investor before investing their amount see the credit ratings of that company. Credit ratings are the essential element of every company’s financial position. But what are credit ratings? Why they are given so much importance in the company’s financial position?
Let us disused about the Credit ratings:
Definition of ‘Credit Rating’:
Credit rating is an analysis of the credit risks associated with a financial instrument or a financial entity. It is a rating given to a particular entity based on the credentials and the extent to which the financial statements of the entity are sound, in terms of borrowing and lending that has been done in the past. A credit rating can be assigned to any entity that seeks to borrow money which can be an individual, corporation, state or provincial authority, or sovereign government.
Agencies that do the credit ratings:
Credit assessment and evaluation for companies and governments is generally done by a credit rating agency such as Standard & Poor’s (S&P), Moody’s, or Fitch. These rating agencies are paid by the entity that is seeking a credit rating for itself or for one of its debt issues.
Description of Credit ratings:
- 1. Usually it is in the form of detailed report based on the financial history of borrowing or lending and credit worthiness of the entity or the person obtained from the statements of its assets and liabilities with an aim to determine their ability to meet the debt obligations.
- 2. A loan is essentially a promise, and a credit rating determines the likelihood that the borrower will pay back a loan within the confines of the loan agreement, without defaulting. A high credit rating indicates a high possibility of paying back the loan in its entirety without any issues; a poor credit rating suggests that the borrower has had trouble paying back loans in the past, and might follow the same pattern in the future.
- 3. The credit rating affects the entity’s chances of being approved for a given loan or receiving favorable terms for said loan.
Difference between Credit score & Credit ratings:
Credit score applies only to individual while credit ratings apply to business & Governments. Credit scores are derived from the credit history maintained by credit-reporting agencies such as Equifax, Experian, and TransUnion.
An individual’s credit score is reported as a number, generally ranging from 300 to 900.
Credit rating agencies typically assign letter grades to indicate ratings. Standard & Poor’s, for instance, has a credit rating scale ranging from AAA (excellent) to C and D. A debt instrument with a rating below BB is considered to be speculative grade or a junk bond, which means it is more likely to default on loans.
Factors Affeting Credit Ratings:
First the credit rataing agencies will look entity’s past history of borrowing and paying off debts. Any missed payments or defaults on loans negatively impact the rating. The companies future economic potential is also evaluated by the agencies.If the economic future looks bright, the credit rating tends to be higher; if the borrower does not have a positive economic outlook, the credit rating will fall.