Ratings war

"I was outraged when I found out that my company has such a poor credit rating, especially as I have never defaulted on any payment in my life!" This is a common reaction to a commercial view that a firm has a low credit rating according to Debra Pennington, head of intelligence at credit reference agency www.graydon.co.uk.

Such ratings are based on data considered by a credit reference agency on a particular trading entity. But, Pennington explains: "There are quite a few ways to improve the situation. Just as it is important to build a positive credit profile as a consumer, companies that trade on credit, need to do the same."

Firms and partnerships are judged on different criteria to private limited companies because the principal(s) are personally liable. In most cases, a successful trading track record and good supplier relationships will yield the credit required.

For unincorporated businesses, the more information that credit agencies have, the more comprehensive the rating will be. They can only derive a meaningful rating on information received and validated by their databases, says Pennington. This may mean investing time responding to a credit reference agency's enquiry, which they undertake on behalf of one of their clients. The client, in turn, is looking for a way of dealing with your company.

The nature of the business and VAT registration numbers, which give an indication that turnover is above a certain threshold, form part of the validation process.

Pennington adds: "For companies with limited liability, another set of guidelines apply." Here, the creditor is judging the viability of a separate legal entity using as much information as is publicly available; most of the time this information comes from a recognised credit reference agency.

Credit reference agencies provide a service that includes an opinion or recommendation. This will be based on information that the agency has collated through public information and its own investigations, such as historical trend analysis, appreciation of the economic environment and, in some cases, direct contact. Their most likely starting point is Companies House.

For a limited company, there are rules about filing documentation at Companies House. "In the first instance, what message do you think that your creditor will get if your company can't follow the normal filing rules?" asks Pennington.

Keep filing information up to date, don't delay in recording changes of directorship and keep within the statutory filing requirement dates: seven months for a public limited company or ten months for private limited businesses.

When accounts are filed at Companies House more information can be used to make a credit opinion. For limited companies, this is often the basis of a credit rating. "All credit agencies have the equivalent of a 'Coca-Cola formula' for rating companies, each having slightly different ingredients, which make up their own credit ratings," says Pennington.

Filing requirements are fairly minimal for small firms, but the data, when extrapolated, provides key indicators on a firm's performance. The bottom line is always significant; this is a company's net worth. Pennington recommends that a business should keep the net worth positive. File profit and loss accounts, so any downward trend in the net worth can be seen as drawings or losses. Also, retain some profit, so as to annually increase the net worth.

Look at share capital. "How much credit would you offer to a firm where the shareholders are only prepared to put two £1 shares at risk?" asks Pennington. Has a director or shareholder loaned the company money that they do not intend to redeem? Consider capitalising the loan, as this will increase the net worth and may have a positive impact on the credit rating.

Record borrowing terms accurately. Bank loans included in overdraft values will affect the working capital position. Remember that suppliers are interested in ascertaining whether a firm can pay them. Working capital is a measure of cash flow, so it follows that negative working capital will be considered for credit ratings. As current assets are mainly those that can be easily converted into cash, ie stock and debtors, a negative working capital raises a few concerns: the company could be suffering a cash flow problem or be overtrading, at the very least it would not be able to meet all of its liabilities from readily available funds.

Pay suppliers within agreed terms. In today's economic environment payment data is often used by credit agents as a guide to credit worthiness.

Pennington concludes: "Avoid negative information, county court judgments, petitions for winding-up. With the current market conditions and in the prevailing rescue culture, there are more avenues for mediation than ever before."