The most significant aspect of credit rating is that it is an opinion made available for public, influencing decisions by participants in financial markets.
Ratings on small and medium enterprises (SMEs) reflect the rated entities’ overall creditworthiness, adjudged in relation to other SMEs. These ratings are entity-specific, and not specific to debt issuances.
SMEs face more difficulties to raise money from either banks or the capital markets when compared with large firms. Many banks prefer to allocate their resources to large enterprises rather than to SMEs. The reason is that large enterprises have a perceived lower risk of default and reliable financial statements.
SMEs are perceived as riskier mainly from the point of view of lenders due to unorganised status. The SME sector lacks organized information on their industries, their functional details, market shares, competition dynamics and good promoter or management track record.
The credit rating is evaluated by a credit agency in who takes into consideration the quantitative and qualitative attributes.
The rating evaluation criteria would take into account the industry dynamics, operational performance, financial risk characteristics, management capability and the future prospects of the entity for arriving at the overall risk assessment of the SME unit. The detailed criteria involves assessment of Industry Risk, Business Risk, Management Risk, Financial Risk and Project risk.
- Industry Risk
Rating agencies assess the Industry Outlook and Demand Profitability of Industry. The Broader Industry factors plays a crucial role in determining the growth and stability of the entities.
- Business Risk
Rating agencies assess sustainability of the business plan and the long term viability of the entity, customer profiles, Relationship Customers and Suppliers, geographical reach, Customer Base, Product Diversification, Infrastructure and Technology.
- Management Risk
SME mostly dependent on the entrepreneurship and resources of the Promoters, SME may not have different layers of professional management like large corporates. Under Management Risk assessment, the rating agencies assess the promoter’s track record in running a business successfully, Promoters ability to manage the business effectively and to ensure long term sustainability. In addition to these factors rating agencies also assess the organisations structure, quality of systems and processes.
- Financial Risk
Financial Risk Assessment includes assessment of Net worth, leverage, profitability, working capital management, liquidity ratios.
Each rating agency have their own customised models for analysing the financials, for example promoters often bring in investments in the form of unsecured loans, Instead of equity to take the advantage of tax policies, Some rating agencies neither treat those loans as equity nor as debt while assessing financials.
Rating agencies can also contact the bankers to check the credit record of the entity and promoters by assessing the nature of relationships, performance of their loans and bank accounts.
- Project Risk:
If management has undertaken any projects for diversification of expansion of the business, then rating agencies under Project Risk assessment assess whether any related or unrelated diversification / expansion, sources of funding, project execution timelines and impact on the credit profile.
Requisites of a Credit rating
Standard Policies, Procedures and Processes
High Data Quality
Robust MIS reports
Reliable Financial Statements
Deep Engagement with Stakeholders
Forward looking strategies
Challenges of an SME
Administrative Costs of Robust Systems and Processes
Low Quality of Staff and High Turnover
Low Profit Margins
High Cost of Credit
Lack of Collateral
Suggested Measures to Overcome Challenges
Establish strong HR Team with Policies and Procedures
Embrace Best Corporate Practices at a moderated level suiting our business
Establish measurable objectives, independent monitoring and reporting teams on performance.
Effective Engagement with Lenders to negotiate better terms of credit
Efficient, Effective and Profit Oriented Business Plans, Robust MIS and follow-up actions
Advantages of Rating
- Concessional funding:
A good rating can help you gain faster and cheaper credit for your venture.
“If a firm gets a good rating, it can even approach other banks to get a better rate bargain than the one provided by his existing banker.
- Better 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.
We can submit credit rating for tenders and make more credible to get bigger orders
It also provides easier access to other sources of finance such as private equity
Better ratings helped the SMEs retain customers and suppliers, and negotiate better terms with them,
- Tool for self-improvement:
Another advantage of rating is that the highlighting of strengths and weaknesses acts as a trigger for self-correction. It is like a report card for SMEs. The analysis helps them to continuously evolve based on the changing regulation, business requirements and economic scenario.
Initiatives from Government and regulatory bodies
Performance & Credit Rating Scheme was formulated in consultation with Industry Associations, Indian Banks’ Association (IBA) and Rating Agencies, with the objective of creating awareness amongst Small Scale Units (now known as micro & small enterprises) about the strengths and weaknesses of their existing operations and to provide them an opportunity to enhance their organizational strengths.
Under this scheme envisaged that the fee payable by MSE to the rating agencies is subsidized up to 75% of the fee, which is categorized into three slabs based on the turnover of the units
Important Tools / Measures to Establish and Improve SME Credit rating:
An SME Enterprise shall enhance its performance by improving its performance in all aspects with the help of following:
- Robust MIS Reporting
- Budgeting and Variance Analysis
MIS Reporting & Presentation:
MIS Reporting ensures that an appropriate data is collected from the various sources, processed and is then visualized (data in the form of bars, graphs, and charts) and then presenting the MIS Reports (visualized data) to the management. This provides ease of analysis and helps to gain faster insights from the available data.
MIS Reports are reports (prepared periodically which is either monthly or quarterly in most cases) required by the management to assess the performance of the organization and allow for faster decision-making. There are different types of MIS reports like Sales Reports, Inventory Reports, Cost Reports, Financial Reports and Cash Flow and Fund Flow statements, etc.
MIS Reporting plays a very important role in the organization by helping the management in strategic planning, operational control and transaction processing.
MIS Reporting creates an impact on the organization’s functions, performance and productivity.
It provides valuable insights into the performance, areas of focus and effective means for monitoring.
- Budgeting helps in controlling the finances if the business by estimating the revenue and expenditure.
- Budgeting ensures that money is allocated to those things that support the strategic objectives of the business and also make sure that the business has funds for future projects.
- Budget helps the management to understand the priorities of the business
- Comparing the budget with actuals (Budget Variance Analysis) can provide information that highlights the strengths and weaknesses of the business.
Budgeting helps the business to achieve its objectives by operating in a smooth manner. It helps with both planning and control of the finances of the business. If there is no control over spending, planning is pointless and if there is no planning it is strenuous to achieve the business objectives.
We at C&B help the management by ensuring high quality data availability, timely budgeting, periodic MIS Reporting services to help the management in assessing the future and current scenario of the entity and the Industry to prepare for a sustained growth.
Any organisation including SME can improve its performance in all aspects by implementing the budgetary control and with robust MIS Reporting can initiate timely actions which shall lead to proper credit rating and overall organisational development.