WE CONTINUE to hear that SMEs will drive the economy out of recession and that the government wants to boost enterprise. This rhetoric, although inspiring in theory, is not working on a practical level. According to the BDRC Continental second quarterly SME finance monitor, over the last three months 70,000 SMEs have had overdraft applications refused, and a further 54,000 have had their loan requests rejected.
The financial issues SMEs are facing continue unabated. Credit ratings are another major concern; our firm has recently conducted its second round of research into three major credit rating agencies: Experian, Dun & Bradstreet and Creditsafe, and identified some staggering inconsistencies. The average variation between the ratings given by these three companies was 150%. In one of the more astounding cases, the credit limits given were zero, £6,000 and £68,000.
The agencies are also inconsistent in their perception of the risk of the same business. Over the period 2010–11, one business had its credit limit increased from £67,000 to £108,000. This same company had its credit limit reduced from £25,000 to £8,400 over the same period by a different credit rating agency.
Why does this matter? A company’s credit rating is an indication of the strength of the business. Receiving an incorrect rating could have catastrophic consequences.
Businesses across the UK rely on these agencies when making decisions about whom to contract with, and believe that there is some over-arching regulation in place or, at the very least, a similar method of calculation is used. This is clearly not the case. Different agencies will have developed their own methods to suggest limits and evaluate risk, but the inconsistencies uncovered demonstrate how far apart these methods really are.
In the current climate, with businesses having to prove their viability to everyone from suppliers to banks and investors on a daily basis, an incorrect rating will have a serious impact on their ability to trade or raise finance. Inconsistent credit ratings are a two-way problem. If suppliers are looking to extend credit terms, and an incorrect rating leads them to either reduce or remove their terms, there will be added pressure on working capital.
From the other side, what if a business decides to supply a new customer based on an inflated credit limit? If their genuine position is masked, it could have catastrophic consequences for a business with little reserves.
Without a uniform set of rules or criteria, credit ratings for Britain’s businesses are, and will remain, a ‘lucky dip’. This is having dire consequences for the SMEs the government proclaims to be the lifeblood of society. Credit rating agencies must be forced to introduce a code of transparency at the very least. Industry regulation or government initiatives must push for greater uniformity to bring these variances into line.
As we continue to wait for these changes to be implemented, it is vital that Britain’s businesses are educated about the situation. This devastating problem is not going away, but it is going unnoticed. Business owners continue to believe that there is consistency and continue to trade on the basis of these ratings.
SMEs can help themselves; they have a responsibility to provide the agencies with as much information as they can. If they leave the agency to rely on information in the public domain, they are asking for unrepresentative figures. Refusing to supply all the information, filing abbreviated accounts and generally having a closed-book approach is a consistent theme that must be broken.
It is important that businesses are also aware of the less obvious things that can have a negative effect. Moving registered office, changes in officers and moving the accounting reference date can all have an impact on the suggested limit.
Credit ratings will remain a significant tool in the choices businesses make. They can be the difference between trading and not trading, so it is vital to get them right. Relying on incorrect ratings will not only put a strain on working capital, but could in the end have devastating consequences. This remains a serious problem for businesses, as the suggested limits all affect the ability to raise finance, the terms set by suppliers and the likelihood of getting an overdraft or loan from the bank.
If, as the government says, the SME sector really is the area of the economy that will drive Britain out of recession, every hurdle in their way must be removed. The inconsistency in credit ratings is clearly an issue that must be addressed to better support the recovery that the economy still craves.
Bobby Lane is a partner at Shelley Stock Hutter