Chapter 4 Integrating cash and trade
understanding the scope of credit ratings.
In particular, ratings analysts do not always
have access to specific data on trade – there
may be not even be specific data – and in any
event they are not assessing the likelihood
of a company refusing to make payment
in a particular contract. Rather, they are
considering the likelihood of the company
defaulting on its particular bond interest or
other security obligations.
The second weakness of credit ratings
is that they may only cover a small number
of a company’s potential counterparties.
Most particularly the credit rating agencies
are unlikely to cover smaller entities in
smaller, emerging markets. Privately owned
companies that do not raise finance on
the external bond or money markets do
not generally attract a credit rating. Even
subsidiaries of larger organisations which do
have a credit rating will not usually have their
own credit rating, unless they operate in the
markets on their own account. It is important
to establish the rating or financial strength of
the exact legal entity with which the company
is dealing. A strong parent has no obligation
to support a failing subsidiary, unless specific
guarantees have been obtained.
The key point is that, because of the
approach credit rating analysts take,
companies should not rely solely on the
rating reports when assessing credit risk.
However, some of the information provided
by credit rating agencies, notably the
detail in published credit rating reports,
will flag risk factors and may give advance
warning of a counterparty’s problems
and, especially, its exposure to particular
markets. In summary, credit ratings are
usually only a relatively blunt instrument to
use to assess the likelihood of being paid
for a specific contract.Credit checking agencies
A second source of information when
assessing potential counterparty risk is
specialist credit checking agencies. For a fee,
companies can access credit reports prepared
by specialist providers. Their focus is on
providing commercial, rather than financial,
counterparty risk analysis. A typical report will
cover a range of information including: Company details.
These will include former trading names
as well as company addresses. Both are
useful as protection against fraudulent
transactions. Some agencies include
detailed reports on the company’s
directors and its senior management.
These will include details of any court
judgments made to order the company to
make a payment. Company valuation and capitalisation.
Details of company share ownership,
indicating the existence of its subsidiaries
and also, where applicable, the identity
of a company’s beneficial owner, whether
it is operated as part of a group or with
private equity investor ownership.
Financial analysis.
This will include an analysis of the
company’s core financial reports (balance
sheet, income statements and other filings,
although for smaller entities these may be
unaudited), as well as the presentation of
core working capital ratios, including DPO,
to give an indication of the speed at which
the company pays. These reports also
provide liquidity and gearing ratios, which
show the level of cash available and the
company’s reliance on external borrowing.
Financial report.
Depending on the agency, there may also
be a commentary about the company in
the report. This may simply be a digest of
publicly available information (e.g. press
reports). Alternatively it may include a more
detailed analysis of figures, ratios and
trends presented elsewhere in the report.
The report might include a comparison
of key data with other companies in the
same industry.
Finally, the report may include an
overall score, often expressed in the
form of a ranking amongst the population
covered rather than an absolute measure.
These reports can be very helpful to
companies seeking to transact with new
counterparties. There is a small number of
international credit check agencies which
provide information on companies located in
most of the larger trading countries around