Credit rating

Definition

A credit rating is an evaluation of the credit risk of a prospective debtor, predicting their ability to pay back the debt and an implicit forecast of the likelihood of default. Credit ratings are issued by credit rating agencies and are crucial for determining the terms on which businesses can obtain financing.

5 Must Know Facts For Your Next Test

1. Credit ratings affect a company's ability to secure trade credit from suppliers.
2. Higher credit ratings typically result in lower interest rates on borrowed funds.
3. Credit ratings can influence working capital management by affecting cash flow and liquidity.
4. Businesses with poor credit ratings might need to offer more collateral or accept less favorable terms.
5. Credit rating agencies like Moody's, S&P, and Fitch provide these evaluations using standardized metrics.

Review Questions

• How does a company's credit rating impact its ability to manage working capital?
• Why are higher credit ratings associated with lower interest rates?
• What role do credit rating agencies play in evaluating a company's financial health?

Related terms

Trade Credit: A form of short-term financing where suppliers allow buyers to purchase goods or services on account.

Working Capital: The difference between a company's current assets and current liabilities, used to measure its efficiency and short-term financial health.

Liquidity: The ease with which an asset can be converted into cash without affecting its market price.