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Corporate Debt Ratings - Essay Example

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Independent credit analysis companies like Moody's or Standard and Poor's issue debt ratings for publicly-traded organizations, using a scoring system that uses numbers or letters. The purpose for these scores is to assist investors and potential investors in making financial decisions on the company's health and future success…
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Corporate Debt Ratings
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Download file to see previous pages Rating Agency Criteria. When setting the actual rating for a specific company, most credit rating agencies use different criteria for different industries. This makes perfect sense because it would not be reasonable to evaluate a financial services company in the same way that a retail products manufacturer is analyzed. Although there are different ways of looking at different companies, most investment credit rating issuers use four general categories to determine an organization's financial health.
The first category used is the size of the company. Although size is not always an indicator of financial health, it does impact a company's credit because larger companies usually have more "resources...which can reduce volatility and lower credit risk" (Lee 7). This means that a larger company can survive a period of lower sales or higher expenses, and will not default on its debt as quickly as a smaller company might if the economy turns down. Investors, especially those that invest in debt instruments like bonds, are very concerned with an organization's ability to pay its debts. Another important criterion is that of product diversity and profitability. If an organization is dependent upon only one or two products to provide its primary revenue, it is more likely to have difficulty repaying its debts than a company that has many hundreds of products. Also, if the profitability of the product line is high, the organization is more likely to have the money needed to pay interest or dividends; meaning that it is a better investment than a company that makes less on its sales. A third consideration for credit rating companies and investors to consider is the financial strength of the company itself. This is a function of balance sheet information that reflects such quantifiable values as debt-to-equity ratios, liquidity analysis, gross profit margins, and return on investment. The financial strength of a company is also shown by the amount of sales it has had, the amount of cash in the bank, how much money it owes to its creditors, and other financial information. Finally, the credit rating services will examine an organization's financial policies to ensure that it is conducting its business according to appropriate laws and accounting rules. This category of analysis helps investors to have confidence that the reports the company issues are accurate, and that there is a less likely chance that negative financial information will be undiscovered or ignored.
There are other criteria used by rating services, but these four show how a combination of items can reflect the relative financial strength of an organization. If a company is large with many different products, a lot of cash in the bank, and always reporting its financial information accurately, it is much more likely to survive any economic crisis than an organization that is small, poor, and dishonest. The higher rating given to the better company lets investors know that their money is less likely to be lost due to default.
Rating Agency Importance. Investment ratings from these agencies are very ...Download file to see next pagesRead More
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