Credit ratings can be used to evaluate the risk of partnering with a business. But what do they indicate? How do you interpret them? What do they suggest about businesses providing human capital management (HCM) products and services? We’ll discuss that and more in this blog post.
What is a credit rating?
A credit rating reflects a company’s financial stability and reliability. Lenders and investors use these ratings to evaluate the risk of giving businesses financial credit. The ratings tell lenders how likely companies are to repay their debts on time and, therefore, how worthy the businesses are of receiving credit. Individuals, businesses, investors, suppliers and vendors — anyone with access — may use the ratings to evaluate companies’ financial health and decide if a partnership is worthwhile.
How are credit ratings calculated?
The three major credit ratings agencies — S&P Global Ratings (S&P), Fitch Ratings (Fitch) and Moody’s Investors Service (Moody’s) — use a wide range of quantitative and qualitative metrics to calculate credit ratings. The specific factors vary between the three. The agencies may evaluate competitiveness, business scale, business profile, business risk, profitability, leverage, diversification, capital structure, financial policy, liquidity and more.
“It’s basically, to a large extent, ‘What’s your scale, do you have revenue in the United States or internationally, are you diversified, what is your competitive position, are you a leader in your market and how aggressive are you about leverage?”” says Kristin Krieg, vice president, assistant treasurer, ADP.
How do companies get credit ratings?
Companies can initiate the credit rating process, but they need debt first.
“Unless you have public or private debt, you can’t be rated,” Krieg says. “You need some debt in your capital structure.”
Companies must also pay to be rated.
“The cost is not immaterial,” Krieg says. “And you have to be willing to spend time with a ratings agency every year or two years. It’s definitely an investment. It’s not a trivial process.”
Companies initiate the rating process because they want to develop an investor base. It’s usually something larger and more mature companies do.
How are credit ratings accessed?
Credit ratings are typically public information. They can be found online.
“They are readily available,” Krieg says, “but if you want to dig deeper and see what’s in the credit reports, that’s harder. You can’t get access to those without paying the credit rating agencies.”
The ratings are typically publicized because they’re attached to bonds or mentioned in press releases. If you’re looking for a specific rating, try Googling the company’s name and “credit rating.” Remember, however, that not all companies have credit ratings.
What is a ‘good’ credit rating?
A “good” credit rating depends on the rating agency’s credit rating scale. A “good” rating per the S&P and Fitch scale is between AAA and BBB-. A “good” credit rating per the Moody’s scale is between Aaa and Baa3.
Credit rating scales: Examples
*Visit this page for more information on investment-grade debt.
**Visit this page for more information on non-investment-grade debt.
S&P rating scale
From highest to lowest, the S&P rating scale is as follows:
- Investment-grade debt: AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-
- Non-investment-grade debt: BB+, BB, BB-, B+, B, B-, CCC+, CCC, CCC-, CC, C, D
Fitch rating scale
From highest to lowest, the Fitch rating scale is as follows:
- Investment-grade debt: AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-
- Non-investment-grade debt: BB+, BB, BB-, B+, B, B-, CCC+, CCC, CCC-, CC, C, D
Moody’s rating scale
From highest to lowest, the Moody’s rating scale is as follows:
- Investment-grade debt: Aaa, Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2, Baa3
- Non-investment-grade debt: Ba1, Ba2, Ba3, B1, B2, B3, Caa1, Caa2, Caa3, Ca, C
What is an example of a credit rating?
One example of a credit rating is an “AAA” rating assigned by S&P. This rating indicates that a company is highly unlikely to default on its debt obligations, a likelihood that many investors, lenders and other stakeholders find attractive. What’s the difference between a credit rating and a business credit score?
A business credit score is a more informal view of a company’s financial strength. It also reflects a company’s ability to repay its debts on time. It is typically developed for private companies, using a business’s vendor payment history or the personal credit history of the company’s founders or owners. Conversely, credit ratings are generally only available for public companies that have issued public or private debt.
Why should I care about my HCM provider’s credit rating?
Companies should always be thoughtful about who they partner with. A strong credit profile means the HCM provider should have ample liquidity and prudent financial policies, which help ensure your payroll and tax payments are properly safeguarded.
If an HCM provider doesn’t have a strong credit profile, you may want to insist that funds be held in a bankruptcy remote trust pending transfer to employees, tax authorities and other payees. This can help ensure the right people, including employees, get paid during a bankruptcy or business failure.
The bottom line: Partner with a provider that has a strong credit rating
Ensure your HCM provider has a strong credit rating. Select a provider with a prudent approach to liquidity that has demonstrated its ability to consistently meet its financial obligations.
ADP’s credit ratings
ADP maintains strong credit ratings. You can view them anytime in our corporate fact sheet. We also carry a bankruptcy remote trust pending transfer to client employees, tax authorities and other payees.
When you partner with ADP, you can rest assured we’re committed to maintaining strong credit ratings. Our stability and reliability help us provide unmatched products and services while protecting your ability to pay your people.
Find out why clients trust ADP.
This article originally appeared on SPARK powered by ADP.
