In: Accounting
1)
Credit Ratings :-
Credit Rating is an assessment of the borrower (be it an individual, group or company) that helps to determines whether the borrower will be able to pay back the loan on time, as per the loan agreement. It is Needless to say that, a good credit rating depicts a good history of paying loans on time in the past. This credit rating influences the bank’s decision of approving your loan application at a considerate rate of interest.
Individual credit is scored from by credit bureaus such as TransUnion on a three-digit numerical scale using a form of Fair Isaac (FICO) credit scoring. Credit assessment and evaluation for companies and governments is generally done by a credit rating agency such as 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.
A loan is a debt—essentially a promise, often contractual, and a credit rating determines the likelihood that the borrower will be able and willing to 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. The credit rating affects the entity's chances of being approved for a given loan or receiving favorable terms for said loan.
Credit ratings apply to businesses and government, while credit scores apply only to individuals. Credit scores are derived from the credit history maintained by credit-reporting agencies such TransUnion etc. An individual's credit score is reported as a number, generally ranging from 300 to 850. Similarly, sovereign credit ratings apply to national governments, while corporate credit ratings apply solely to corporations.
A short-term credit rating reflects the likelihood of the borrower defaulting within the year. This type of credit rating has become the norm in recent years, whereas in the past, long-term credit ratings were more heavily considered. Long-term credit ratings predict the borrower's likelihood of defaulting at any given time in the extended future.
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 a speculative grade or a junk bond, which means it is more likely to default on loans.
A credit rating is, however, not an assurance or guarantee of a kind of financial performance by a certain instrument of debt or a specific debtor.
2)
The Credit ratings are used in market place in the following manner :-
i) Credit rating is used by the investors for making investment decision about the debt or equity of company, based on the credit rating which company has received from credit rating agency.
ii) Credit rating is also used by a company; because a company which has received good credit rating can raise funds easily from either capital markets in the form of issue of equity shares or from debt markets in the form of bonds.
iii) Credit rating has regulatory importance also because if company is going for initial public offering than it is compulsory for it to get credit rating before issuing shares to public, so that investors know about the company before applying for the initial public offering.
iv) Credit rating is also used by companies when they take loan from the banks or other financial institutions.
v) Credit rating is also used to judge about the overall operational efficiency and efficiency of the top management in running the business of a company.