To proactively manage financial performance and capital structure, companies must focus on strategies that ensure a favorable credit rating while minimizing rating shocks. Hence, it is important to implement robust forecasting and budgeting processes. This includes projecting future cash flows, maintaining a balanced debt-to-equity ratio to optimize gearing levels, ensuring adequate liquid cash reserves, and access to unused credit lines. Furthermore, periodic reviews of working capital requirements and avoiding excessive leverage are also essential to uphold key credit metrics.

Key financial metrics that credit rating agencies prioritize include profitability ratios - such as operating margins, net margins, and return on capital employed (RoCE) - as well as capitalization and coverage indicators like gearing ratios, total debt as a percentage of operating profit before depreciation, interest coverage, and the debt service coverage ratio (DSCR). Working capital indicators, including net working capital intensity, debtor and inventory days, and cash flow analysis - focused on retained and free cash flows are also critical for arriving at a rating conclusion.

To strengthen relationships with credit rating agencies, corporates should assign a single point of contact (SPOC) to manage all communications and queries. Engaging expert rating advisors with prior analytical experience is essential to ensure transparency and accuracy during the rating process. These experts facilitate timely information sharing, ensuring that all required documents and evidence are provided, schedule meetings involving senior management to address queries, discuss future projects, and share forward-looking statements with the rating agencies. Regular communication between the SPOC and the rating agency is crucial  to foster a transparent and well-informed relationship, ultimately enhancing their credit rating profile.

Aligning Operations and Financial Reporting to Safeguard Credit Ratings

Implementing a comprehensive risk management framework that continuously assesses both operational and financial risks is crucial. Key risks such as supply chain disruptions, market volatility, and credit risks should be closely monitored, with swift corrective measures taken to mitigate potential impacts. Also, conducting sensitivity analysis under various economic scenarios helps companies anticipate the effects of these risks on financial performance. Hence, regularly reporting these assessments and outcomes to stakeholders ensures transparency and preparedness.

Additionally, strategically aligning operational decisions with financial reporting and risk management is essential to navigating periods of economic uncertainty. This approach not only protects a company’s credit rating but also demonstrates resilience. So, devising an integrated strategy safeguards financial health while fostering stakeholder confidence, ultimately positioning businesses to withstand economic challenges without risking a credit downgrade.

It is also important to note that credit rating changes - particularly downgrades and negative outlook revisions - can have long-term consequences for a company's financial health and market competitiveness. For instance, downgrades lead to higher borrowing costs as lenders perceive greater risk, limit access to fresh debt and capital markets, and may trigger penalties if existing debt agreements are tied to specific rating thresholds. These changes also erode investor confidence, signaling potential issues, forcing investment strategy shifts, and increasing reputational risks, making it more challenging to attract new investments. Additionally, companies face heightened scrutiny from rating agencies, regulators, and equity analysts, which limits financial flexibility and weakens market competitiveness.

To mitigate these effects, companies must maintain a robust risk management framework, a healthy balance sheet, and transparent communication with stakeholders. In addition to these, diversifying funding sources and engaging proactively with rating agencies are also essential steps. By taking decisive actions to retain favorable ratings and address risks, companies can protect their financial standing and uphold market competitiveness, minimizing the long-term impact of rating changes.

Significance of Credit Rating Diversification in Corporate Risk Management

Credit rating diversification, or securing ratings from multiple agencies, plays a crucial role in a corporation’s overall risk management strategy. Therefore, large corporates should obtain ratings from at least two agencies. This approach enhances credibility with lenders, provides a broader perspective on a company’s creditworthiness, and mitigates potential bias stemming from varying methodologies used by different agencies. Additionally, having dual ratings can incentivize agencies to maintain high standards, as it preserves the issuer's bargaining power in the event of a negative rating action.

While there are benefits, companies must also consider the associated costs. Rating fees typically represent a percentage of the sanctioned debt and can vary based on each agency’s fee structure. Also, the rating process can be time-consuming and may require dedicated internal resources, not only during the initial assessment but also for monthly regulatory declarations and periodic reviews.

So it is advisable that small and mid-sized corporates carefully evaluate the feasibility of maintaining relationships with multiple agencies, as balancing the costs and benefits demands strategic planning. For larger entities, dual ratings offer enhanced market confidence, access to a broader investor base, and improved financial flexibility, ultimately outweighing the costs and supporting long-term strategic goals.

About the Author

Nishant Lakkar is the Founder and CEO of AAA Rating Consultants and Advisors (AAARCA), specializing in credit rating advisory services and financial consultancy for public and corporate sector entities. With an MBA in Finance and over 15 years of experience in the credit rating industry, he possesses a profound understanding of market dynamics and rating criteria across various sectors and regions. Nishant utilizes his expertise in financial risk management, corporate finance, credit ratings and sectoral research to deliver customized solutions for his clients. As of September 30, 2024, he has advised on bank loan credit ratings exceeding Rs. 3,800 crores, developed balance sheet improvement plans for five corporations, and facilitated two entities in securing long-term solar power purchase agreements totaling over 40 MW.