What is a Credit Risk Rating?

A credit risk rating is an evaluation that takes into account various financial factors associated with an individual or business and determines the degree of risk that a lender would assume by choosing to offer credit or loan privileges to that individual or company. The results of the evaluation are expressed in a rating based on a defined scale of qualifications. A lower credit risk rating indicates that the debtor is unlikely to default on the extended credit and poses little risk for the lender. In contrast, a higher credit risk rating indicates that extending a loan or line of credit to the debtor poses a significant level of risk and should be considered very carefully before approving a loan or credit application.

While a credit risk rating is often assessed by lenders who are considering applications from potential clients, companies also sometimes conduct what is known as an internal credit risk rating. In this scenario, company owner and managers attempt to assess the financial stability of the business using the same criteria utilized by lenders. Doing so has the benefit of allowing the company to identify areas of concern, develop strategies to minimize those concerns and improve their chances of securing credit when an application is made to one or more lenders.

The credit risk rating is determined after conducting what is known as a credit risk analysis. Here, specific information about the past financial activities of the business, its current assets, and its prospects for the future are taken into consideration. The idea is to base the rating on all known data about the business, while also considering its prospects for remaining a viable business entity for at least the duration of the loan or credit agreement. Determining a credit risk rating may involve the use of additional qualifications, depending on the nature of the loan or credit the company is seeking, factors associated with the industry in which the company operates, and the projections of continued profitability even in the face of changing economic situations and new innovations in technology.

It is important for individuals and companies to remember that a low credit risk rating does not have to remain at that level. Identifying the reasons for the lower rating, as well as understanding the criteria that specific lenders use when reviewing applications, will make it easier to implement specific strategies to improve the rating over time. While this means that the company may not be able to obtain the desired financing at present, diligently working to remove obstacles and improve the circumstances of the company are highly likely to improve the chances of securing the financing at a later date.