Chapter4

Credit rating methodology

Research methodology: research design or research methodology is the procedure of collecting
analysis collecting analysis and interpreting the to diagnose the and problem and react to the
opportunity in such a way where the costs can be minimized and the desired level of accuracy
Can be achieved to arrive at a particular conclusion.
The methodology used in the study for the completion of the project and the fulfillment of the
project objective.
The primary data used for the study is through interaction with employees and financial manager
of the organization the secondary data taken under the study is gather from journals magazines
news paper and through company website etc.
Source of data collection: both primary and secondary data has been used in this study.
Primary data:
Primary data is which collected first time is or it is also called as fresh data.in this study ,personal
interviews will be taken using structured questionnaire.
Secondary data:
Secondary data is data which is collection by one and used by the other person.it is not a fresh
data. In this project data is collected from secondary source such as internet , brochures, books,
newspapers magazines etc.
1.Business risk analysis
2.Financial analysis
3.management evaluation
4.Geographical analysis
5.Fundamental analysis
6.Regulatory and competitive environment
These are explained as under.
1.Business risk analysis:
This includes an analysis of industry risk market position of the company ,operating
efficiency of the company and legal position of the company.
(a)industry risk:
The rating agencies evaluates the industry risk and by taking into consideration various
factors like strength of the industry prospect ,nature and basis of the completion ,demand
and supply position structure of the industry ,pattern of the business cycle, industries
Chapter4

complete with each other on the basis of price product quality distribution capability
etc .are in a strong position and therefore enjoy better credit rating.

(b)market position of the company:

Rating agencies evaluates the market standing of a company taking into account
Percentage of market share
Marketing infrastructure
Competitive advantages
Selling and distribution channel
Divergent of product
Customer base
Research and development project undertaken to identified obsolete products,
Quality improvement programmes.
(c) operating efficiency:
Favorable location advantages, management and labour relationships, cost structure
availability of raw materials, labour, compliance to pollution control , programmes , level of
capital employed and technological advantages etc. affect the operating efficiency of every issuer
company and hence the credit rating.
(d)Legal position:
Legal position of a debt instrument is assured by letter of offer containing.terms of issue,mode
of payment of interest and principal in time,provision for protection against fraud etc.affect the
credit worthiness.
(e)size of business:
The size of business of the company is a relevant factor in the rating decision .smaller
companies are more prone to risk due to business cycle changes as compared to large companies.
smaller companies operations are limited in terms of product, geographical area and number of
customer .where as large companies enjoy the benefit of diversification owing to wind range of
products, customers spread over larger geographical area.
2.Financial analysis :
This includes an analysis of four important factors namely :
(a)accounting quality
(b)earnings potential /profitability
Chapter4

(c)cash flows analysis

(d)financial flexibility
Finance analysis aims at determining the financial strength of the issuer company through
quantitative means such as ratio analysis .both past and current performance is evaluation to
comment the futur performance of accompany .the areas considered are explined as follows
(a)accounting quality:
As credit rating agencies rely on the audited financial statement ,the analysis of statement
begins with the study of accounting quality .for the purpose ,qualification of auditors
,overstatement /understatement of profit s, method adopted for recognizing incom,valuation of
stock and charging depreciation on fixed assets are studied.
(b)Earnings potential/profitability:
Profits indicate company ability to meet its fixed interest obligations in time.a business with
stable with stable earnings can withstand any adverse conditions and also generate capital
resources internally .profitability ratio like operating profit and net profit and net profits ratio to
sales to sales are calculated and compared with last 5years figures or compared with the similar
other companies carrying on same business.as a rating is a forward looking exercise more
emphasis is laid on the future rather than the past earning capacity of the issuer.
(c)cash flow analysis:
Cash flow analysis is undertaken in relation to fixed and working capital requirements of the
company.it indicates the usage of cash for different purposes and extent of cash avaliable for
meeting fixed interest obligations. cash flows analysis facilities credit rating of a company as it
better indicates the issuer debt servicing capability compared to reported earnings.
(d)financial flexibility:
Existing capital structure of a company is studied to find the debt /equity ratio, alternative
means of financing used to raise funds, ability to raise funds, asset deployment potential etc. the
future debt claims on the issue as well as the issuers ability to raise capital is determined in order
to find issuer financial flexibility.
(3)management evaluation:
Any company performance is significantly affected by the management goals ,plans and
strategies, capacity to overcome unfavorable conditions ,staffs own experience and skills,
planning and control system etc. rating of a debt instrument requires evaluation of the
management strength and weakness.
(4)Regulatory and competitive environment:
Credit rating agencies evaluated structure and regulatory framework of the financial system in
which it work .while assigning the rating symbols, CRAs evaluate the impact of regulation
/deregulation on the issuer company.
Chapter4

(5)Geographical analysis:
An issuer company having its business spread over large geographical area enjoys the benefits
of diversification and hence gets better credit rating. a company located in backward area may
enjoy subsidies from government thus enjoying the benefit to lower cost of operation .thus
geographical analysis is undertaken to determine the location advantages enjoyed by the issuer
company.

(6)Fundamental analysis:
This includes an analysis of liquidity management ,profitability and financial position
interst and tax rates senility of the company. Fundamental analysis is a method of force acting
the future price movement of a instrument based on economic, political, environmental and there
relevant factor and statistics that will affect the basic supply and demand of whatever financial
instrument.
(a)Liquidity management involves study of capital structures, availability of liquid assets
corresponding to financing commitment and maturing deposits ,matching and liabilities.
(b)Assets quality covers factors like quality of company credit risk management ,exposure to
individual borrowers and management of problem credit etc.
(c)Profitability and financial position covers aspects like past profits, funds deployment,
revenues on one fund based activities ,adding to reserves.
(d)Interest and tax sensitivity reflects of company following the changes in interest rates and
change in tax law.
Fundamental analysis is undertaken for rating debt institutions, banks and nonbanking finance
companies.

Scope of the study:

The scope of the study is identified after and during the study is conducted. The project is
based on tools like fundamental and technical analysis, and ratio analysis further, the study is
based on information of last five years.
Chapter4

The analysis the made by taking into consideration six companies ,ICICI bank, HDFC bank
,Axis bank, IDFC bank etc .
*The study is limited for a period of five years.
*the scope is limited to only the fundamental analysis of the chosen.
*the equity analysis of banking and financial stock study is carried out in office of angel
broking limited in Hyderabad.

Limitations:
Every study has to its own limitations in terms of methodology and available resources for its
conduct. This study was not on exception and was carried out under the following limitations .
*this study been conducted purely to understand only equity analysis for investors.
*the study is restricted to six companies, ICICI bank, IDFC bank, ltd. Mahindra & Mahindra
finance and HDFCL , based on fundamental analysis.
*the study is limited to the companies having equities.
*detailed study of the topic was not possible due to limited size of the project.
*there was a constraint with regard to time allocation for the research study for a period of
45days.
*topic is vast but availability of information and timeline is short.
*suggestions and conclusion are based on the limited data of five years.
Chapter4
Chapter4