Define Rating Methodology

Rating Methodology

The rating methodology is a detailed analysis of all the factors affecting the creditworthiness of an issuer company. The important factors are business, financial and industry characteristics, operational efficiency, management quality, competitive position of the issue, commitment to new projects etc.

The credit rating agency analyses the following factors for evaluating the instruments such as:

Business Risk Analysis

Financial Analysis

Management Risk Analysis

Project Risk Analysis

External support

These are explained as under:

Business Risk Analysis

Business risk analysis involves the analysis of the industry risk, market position and operating efficiency of the company which has various factors that depicts in the following chart:

Industry risk

The rating agency evaluates the industry risk by considering the following factors:

Strength of the industry prospect,

Nature and basis of competition,

Demand and supply position,

Structure of industry,

Pattern of business cycle etc.

Market Position

The credit rating agency determines the market position of the issuing company with reference to the following parameters:

Revenue Generation Addressed

Market Size and Segments

Market Share and Trends

Entry Barriers and Capacity

Product Range and Customer Diversity

Competitive Advantages

Brands, Product Quality

Strength of Distribution network and geographical Reach

Long Term contracts for Product off take / marketing arrangement

Ability to pass on Input Cost Increase

Operating Efficiency

Operating Efficiency can be measured by using the following aspects:

Cost Structure

Technology used

Capacity Utilization

Regular up keep / modernization of facilities

Input Structure

Access to resource, cost of key inputs

Level of Integration

Assured, Quality supply of Critical Utilises

Labour Relations – Union

Financial Analysis

Financial risk analysis aims at determining the financial strength of the issuer company. The credit rating agency can use some accounting tools & techniques to analyze the financial risk which are depicted in the following picture.

Accounting Quality

Qualification of Auditors

Inventory Valuation Policies.

Income recognition method

Off Balance Sheet Items

Past and Future Financial Record

Past performance

Capital Structure (Debt – Equity)

Debt Protection measure (Interest Coverage & Cash DSCR) & Liquidity

Profitability Trends in Operating / Net Margins (indicating asset side Performance) – provide a tool to measure cash generation.

Trends in Company’s Funding mix Philosophy – Phasing of Capex Programmes.

Future Performance Based on Industry Trends, Company’s own operations and future plans.

Cash Flow Adequacy and Financial Flexibility

Assess the adequacy and stability of cash Flow in relation to debt, working capital needs and capital expenditure requirement.

Comparison of sources and uses of funds

Ability to raise alternative financing eg. Equity, Quasi Equity, Loans from Promoters

Financial support from group / promoters and its past track record

Availability of un encumbered liquid assets

Management Risk Analysis

Rating of a debt instrument requires evaluation of the management strengths and weaknesses because company’s performance is highly influenced by the management goals, plans, strategies etc., which can be analyzed through the following aspects:

Project Risk Analysis

The instrument issuing company’s project should be evaluated to measure the risk of the project. It is very important for rating debt instrument. The following factors are considered to evaluate the project by the credit rating agency.

Project Size

Implementation risk

Funding Risk

Technology Risk

Track Record in timely implementation

Cost Overruns, contingency

External Factors

The credit rating agency has to analys the external factors and its supports also. They are as follows: