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A signal for an audit

A RATING is mostly known as an evaluation of a company's ability to pay its debts. However, it can also be a signal that there is room for improvement and a challenge to the rated company to address its weaknesses.
"A rating grade could be a sign for ordering an audit if a company does not have the capacity to solve a problem alone.

A RATING is mostly known as an evaluation of a company's ability to pay its debts. However, it can also be a signal that there is room for improvement and a challenge to the rated company to address its weaknesses.

"A rating grade could be a sign for ordering an audit if a company does not have the capacity to solve a problem alone. Many people do not distinguish between a rating and an audit," said Miroslav Kňažko, country analyst with the CRA rating agency, a Moody's Investors Service affiliate in Slovakia.

The customer can be a company, municipality, or even an investment project and can use a good rating as a point of strength in negotiations with banks and financial institutions to acquire better loan conditions.

Rating agencies carry out a thorough analysis of a company based on financial and non-financial indicators. A final rating grade mainly indicates whether the subject will be able to pay its debts in the future.

When an agency lowers a subject's grade, it usually cites the most deteriorated areas of its customer's performance to back its decision. However, an agency never suggests how a company can eliminate its shortcomings.

"Our recommendations are general. We can find out that, for example, costs on salaries are too high compared to a company's income, but we do not do detailed research on staff structure. That is not our job. This is something for personnel auditing companies," explained Kňažko.

The results of rating agencies' research can show that a company has serious problems in its financial, personnel, environmental, market policy, or other areas.

Specialised auditing companies should be able to look at identified problems more closely and find solutions.

On the other hand, rating agencies must maintain an independent approach, which is why they are not allowed to provide consultant services.

"We can suggest frame recommendations, but we must stay unbiased. If we want to evaluate a company's credit risk, we cannot be their advisers and afterwards tell them that they did a good job and increase their rating," said Kňažko.

Credit ratings were first used in the beginning of the 20th century during the US railway boom, which could be compared to today's explosion of internet firms. Ratings helped investors become more familiar with bonds issued by railway companies. They showed how likely it was that a bond would bring a yield when it matured.

Bond issuers are still the most likely customers of ratings agencies. Apart from governments that need to refinance their state debts, there are also industrial and financial companies, municipalities, and companies that manage investment projects.

"Companies in Slovakia already know the meaning and possibilities of ratings. Municipalities still have to get used to them. We just have to give it time," added Kňažko.

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