External Credit Risk Ratings Explained

External credit risk ratings and how they are used in the SME Finance MonitorThe external credit risk rating held on businesses by companies such as Experian and Dun and Bradstreet are used by banks and other lenders as one of the assessment factors for lending decisions. A poor credit history, or lack of credit history is regularly cited by SMEs asked why they think they were declined by their bank.

Credit risk ratings are appended to the results of the SME Finance Monitor, so what does analysis tell us?

Over time, more SME businesses have been rated a “worse than average” risk

  • In Q1 2013, 55% of businesses had this risk rating, up from 48% in the equivalent quarter of 2011
  • 16% had a minimal or low risk rating, down slightly from 19% in 2011

The external risk rating profile improves with size of business

  • In Q1 2013, 10% of 0 employee businesses had a minimal or low external risk rating, compared to 57% of those with 50-249 employees

The external risk rating also improves with age

  • In Q1 2013, less than 1% of Start ups had a minimal or low risk rating, compared to 35% of those who had been trading for 15 years or more

Businesses in the Agricultural sector have the best external risk profile

  • In Q1 2013, 28% of businesses in the Agricultural sector had a minimal risk rating compared to 1% of those in the Transport sector
  • At the other end of the scale, 75% of those in the Transport sector had a worse than average risk rating, compared to 26% in Agriculture

External risk rating has been shown to be a significant predictor of the outcome of a loan or overdraft application, along with number of employees. Of applications in 2012 reported to date:

  • Minimal external risk rating: 98% of overdraft applications, and 72% of loan applications were successful
  • Low external risk rating: 82% of overdraft applications, and 67% of loan applications, were successful
  • Average external risk rating :89% of overdraft applications, and 50% of loan applications, were successful
  • Worse than average external risk rating: 65% of overdraft applications, and 41% of loan applications were successful

While an SME thinking of applying for finance is unlikely to make immediate changes to the size, or age, of their business analysis has shown that there are other steps that businesses can take to improve their chances of success:

Avoiding credit issues

Managing your business finances to avoid credit issues (and hence avoid damaging your external risk rating) can make a difference to the outcome of an application. In Q1 2013, 11% of SMEs reported some form of credit issue in the year before they were interviewed, typically an unauthorised overdraft or a cheque bounced on their account, and there was very little difference by size of business

A financial decision maker with relevant training/qualifications

Those who have someone in charge of the finances with a relevant financial qualification or training are more likely to be successful with an application, but not all SMEs have such a person. Overall, 24% of SMEs have such a person in charge of their finances, and this increases with size from 21% of those with no employees to 74% of those with 50-249 employees

Producing regular management accounts

Businesses that keep a regular eye on their financial performance through the production of management accounts are more likely to be successful with an application. 4 out of 10 SMEs currently produce such accounts with marked differences by size of business – a third of those with no employees produce management accounts, rising to 9 out of 10 of those with 50-249 employees

For more information see BDRC Continental’s SME Finance Monitor

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