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Credit scoring in the current environment: what businesses should know

Author: ICAEW Insights

Published: 25 Jun 2021

The economic and business challenges associated with COVID-19 have many businesses looking nervously at their credit scores. With this in mind and given the exceptional set of circumstances facing businesses at present, ICAEW’s Philippa Kelly and Louise Sharp have been speaking to some of the credit reference agencies and other relevant stakeholders about the impact of COVID-19 on SME credit referencing.

Credit ratings agencies and credit reference agencies (CRAs) balance a combination of predictive and lagging indicators to draw a conclusion about a company’s credit risk. 

In terms of financial information, many CRAs primarily focus on the balance sheet and profit and loss account as, historically, audit reports, particularly for smaller businesses, have not always contained the sort of additional information which would further inform the scoring exercise.

The COVID-19 pandemic is, however, having an impact on company audit reports, with more material uncertainty paragraphs relating to going concern, emphasis of matter paragraphs and modified audit opinions. This has meant that CRAs must assess whether this additional source of information about the business is incremental information that could be a leading indicator to apply to scorecards to improve predictiveness. The approach taken and methodologies used will likely differ from one CRA to the other.

One major CRA told ICAEW that certain disclosures within an audit report are included when scoring a business, but that this wouldn’t happen mechanically. For example, a material uncertainty relating to going concern due to the effects of uncertainty created by COVID-19 would be assessed alongside other indicators about the business. The CRA explained that it utilises many different sources of information within its commercial credit products and services, with the aim of providing as much insight to its clients as possible to enable accurate and fair commercial credit decisions. Its reports and scores do include information from audit reports to help assess the commercial credit risk of a business, but it recognises that the COVID-19 crisis is an extraordinary situation and has tailored its approach to reflect this. Audit opinions are considered within the CRA’s scoring but it would not automatically downgrade a business on the basis of a disclosure related to COVID-19.

Another major CRA explained to ICAEW that auditors’ comments are incorporated into its scoring algorithm as part of the general financial statement data-capture process - which is an annual process that aligns to the annual filing of accounts. The impact of this information will therefore remain in place until a fresh set of accounts and new opinion is captured.

Other CRAs may relay the information presented within an audit report as part of the information they provide customers without building it into the credit score itself. “It is also important to recognise that many third parties seeking financial information about businesses will want access to the raw data so that they can make their own judgements about the business, rather than relying on credit scores”, explains Louise Sharp, Technical Manager in ICAEW’s Audit and Assurance Faculty. 

CRAs also use other sources of information, outside of the annual financial statements, to assess businesses. This could include proprietary data about directors, as well as about the business itself. Predictive data to assess the trading position of a business might include:

  • average days settlement beyond invoice terms; 
  • comparison of payment to industry averages;
  • unpaid invoice accounts;
  • whether speed of invoice payment is decreasing (even if within terms or good practice);
  • arrears on current and historical commercial credit agreements;
  • defaults on historical commercial credit agreements;
  • any county court judgments (CCJs);
  • data from companies that the directors are associated with; 
  • consumer credit scores of the directors; and 
  • current account cash flows. 

The inclusion of this additional information is dependent on the breadth and depth of the information held by each CRA, which varies across the industry. Philippa Kelly, Director of ICAEW’s Reputation and Influence Business Group said: “Businesses should be aware of the range of factors which influence a credit score, and the relationship of directors’ own credit scores to the business score, particularly for smaller businesses.”

Some CRAs also track commercial press releases which point to risks the company faces. 

As the uncertainty resulting from COVID-19 continues into 2021, CRAs are keen to ensure that lenders and others retain an accurate picture of risk to facilitate responsible lending, while being mindful of the unique set of challenges currently facing businesses. Indeed, the Financial Reporting Council (FRC) recently held a roundtable which included representatives from Dun & Bradstreet, Experian and Equifax to understand the implications of extensions to filing deadlines and a likely increase in material uncertainty paragraphs relating to going concern on credit references and to explore whether they are being interpreted in a proportionate way.