Thursday 28th April 2005


Assessing the credit quality of manufacturing

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By Muthu Raman

In today’s article, we shall discuss the rating methodology adopted by Caricris in assigning ratings for manufacturing and services companies. Publication of these methodologies is an important part of Caricris’ effort to be transparent and to bring about investor confidence in the analytical robustness and the objectivity of its credit ratings.

Caricris’ framework for assessing credit quality of manufacturing/service companies covers three broad sources of risk that these companies face viz business risk, financial risk and management risk. In addition to these three, if the company is in the process of implementing any large project, project risk is assessed as a separate risk category.

1. Business risk analysis covers the business fundamentals of the rated company, the characteristics of the industry in which it operates, its competitive market position in the industry, its operational efficiencies as well as the state of the economy in which the company operates.

2. Management risk analysis includes an evaluation of the company’s management in terms of its competence in running its chosen lines of businesses, its risk appetite as well as management’s integrity in its dealings with all its constituents.

3. Financial risk analysis includes an assessment of the company’s accounting quality, its past financial performance, Caricris’ assessment of its future performance and its financial flexibility, with particular emphasis on its cash flows.

4. Project risk analysis includes an assessment of the nature of the project, funding pattern for the project and any funding risks, technology/implementation risks in the project, any cost/time over-runs and management’s experience in this line of business.

It must be emphasised here that the above framework is the generalised version of the methodology that Caricris will use to analyse manufacturing and service companies. The analysis of entities in specific industries will be based on customised versions of this general methodology.

Let us now take a closer look at each of the key risk elements.

Business Risk

Economy Risk

For the Caribbean region in particular, risks must be assessed in the context of small, open economies. Factors such as economic stability, how open the economy is to trade in respect of a particular industry, the performance and potential threat of imports, the extent to which the industry players export their goods, the industry’s dependence on government trade support policies and conversely the ability of industry players to overcome trade barriers, the government’s tendency to intervene and the overall performance and structure of the economy are important inputs to the evaluation of business risk.

The relative vulnerability of each Caribbean economy to natural disasters, such as hurricanes, must also be taken into consideration.

Industry Risk

The assessment of the risk posed by the industry in which a company operates includes an examination of market attractiveness, extent of competition, bargaining power with customers/suppliers and government policy.

A market is more attractive if it is bigger, more diversified and less cyclical with respect to revenues and/or costs. Questions such as how important the market is to the overall economy, in what stage of its life cycle is the product and is there imminent risk of product obsolescence must also be answered.

When high barriers to entry and low threats from substitutes characterise an industry, either domestic or imported, then the revenues of entities operating within such an industry are relatively protected. The extent of bargaining power enjoyed by a company with its customers and suppliers also indicates the relative ability to protect margins.

Apart from the foregoing, Caricris takes into consideration a government’s stated or implied position towards an industry as well as any tendency to intervene/support.

Market Position

Market position can be broken down into issues that affect a company’s pricing power such as market dominance, brand equity and price elasticity of demand and an examination of issues affecting revenue stability such as diversity across markets, customers and products. Prospects for growth and sources of competitive advantage are also assessed.

Operating Efficiency

Operating efficiency identifies the factors that impact costs such as the cost structure, efficiency of production and cost efficiencies arising from sourcing, distribution and effective use of technology. Operating efficiency also examines factors that threaten or ensure the continuity of a company’s operations such as labour relations, product development skills and research and development.

A company’s market position and operating efficiency must be examined in the context of the industry in which it operates. Therefore, competitive dynamics such as number of players, market fragmentation, expansion capacity of key players and indicative operational efficiency measures across the industry are key inputs to the assessment of the rated company’s business risk.


The risk arising from management and its actions has the potential to override for better or for worse every other source of risk. Caricris assesses a company’s management across three areas: competence, risk appetite and integrity.

1. Competence examines experience and qualifications, ability to cope with crisis and external factors, skills in human resource management, past track record of performance of the management, stability in the senior management team, adequacy of planning and succession, etc.

2. Risk appetite looks at management’s propensity to borrow and undertake large projects, its tendency to enter new markets and products, and its ability to manage the risks arising from such actions.

When assessing risk appetite Caricris also studies the rated company’s investment and financing policies.

3. Integrity includes aspects such as transparency in group company transactions, transfer pricing, business ethics and the overall corporate governance systems and structures to ensure checks and balances and quality of disclosure.


Caricris begins its financial risk assessment with an evaluation of a company’s accounting policies with a view to determining the degree of transparency and disclosure exercised by management.

Some of the factors examined are the company’s policies on income recognition, depreciation, inventory valuation and off-balance sheet items and contingent liabilities and the consistent application of the chosen policies.

Wherever required, a company’s financial statements are recast to accurately reflect its performance in a format that is comparable over time and across companies.

Caricris constructs financial projections incorporating its expectations on economy, industry and business variables as well as management’s strategic plans. Caricris then uses a variety of financial ratios to analyse a company’s financial strengths, current and future. In addition to earnings, cash flow is closely examined to determine levels and stability over time and projected into the future.

Moreover, Caricris examines a company’s ability to raise funds from a variety of sources in times of stress or crisis. This would include a company’s reserves, relationship with bankers, ability to raise capital from the market, marketable securities/investments and its overall liquidity position.

The key ratio categories analysed by Caricris are profitability, capitalisation, debt coverage, cash flow and liquidity.


If a company is executing or intending to execute a major project, Caricris evaluates the risks associated with that project as an input into the company’s overall credit rating. Risks affecting the implementation and viability of the project such as the likelihood of time and/or cost overruns and risks arising from the funding structure of the project are examined.

Caricris will also take into account the company’s track record in implementing projects of similar magnitude.

The size of the project relative to existing operations as well as its potential impact on existing business indicate to what extent the project risk assessment will impinge on the overall credit rating.

Based on the above, Caricris arrives at the stand-alone creditworthiness of the entity being rated. In addition, Caricris assesses any external support that the entity/rated debt can derive, such as support from a stronger parent or group or other forms of credit enhancement such as a guarantee, if applicable.

Caricris is the Caribbean’s Regional Credit Rating Agency. This article forms part of a series on issues surrounding capital markets and credit ratings.

E-mail: [email protected] or call 868-627-8879.




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