25. On the rating scale of SME1 to SME8, value ranges (in minimum–maximum pairs) for each sub-factor may be set based on the DCRA’s expectations for each rating category. With the ranges identified, the DCRA may map the outcomes for each sub-factor to a rating category: (i) For quantitative sub-factors, such as those related to earnings or profitability, the DCRA could place a firm’s actual EBITDA margin against the SME1 to SME8 scale for EBIDTA to see where it fits.
(ii) For the qualitative sub-factors, the DCRA could assign sub-factor rankings either for all the firms relative to one another or
based on absolute criteria including both quantitative and qualitative parameters. As with quantitative sub-factors, DCRA could use the SME1 to SME8 scale.
Rating Notches Rating Definition
SME 1 Highest quality
SME 2 High quality
SME 3 Adequate SME 4 Moderate SME 5 Inadequate SME 6 Risk-prone SME 7 Poor SME 8 Poorest
Table A2.2: Rating Factors and Sub-Factors and Their Weights
Rating Factors Weight (%)
1. Operational and Business Risk 40.00
Premises, Product and Services, People Element, Purchasing, Protection, Procedures, Performance, Planning, Policy, and Processes
2. Environmental Risk 5.00
3. Financial Risk 35.00
Earnings and Stability 5.25
Sales EBITDA Trends Profitability 5.25 EBITDA Margin ROA Liquidity 3.50 Liquidity Index Current/Quick Ratio
Working Capital Management 7.00
OI/NWC
Sales to Working Capital Limit Average Inventory Period Average Collection Period Average Payment Period
Leverage and Net Worth 7.00
Debt/EBITDA D/(D+E) Coverage 7.00 EBIT/Interest DSCR 4. Management Risk 20.00
Promoter’s Track Record and Qualification 8.00
Management Quality and Succession Planning 6.00
Administrative Setup and Delegation Culture 6.00
DSCR = debt service coverage ratio; EBITDA = earnings before interest, tax, depreciation and amortization; OI/NWC = operating income/net working capital; ROA = return on asset.
Notes:
i. Each rating factor (Factor 1 to Factor 4) is given a weight based on the importance of that particular factor in the rating. The sum of factors weighted should equal to 100. The weights assigned to various parameters may vary from SME to SME depending on the specifications of the said enterprise.
ii. Based on the risk analysis, each sub-parameter is assigned an appropriate rating score.
iii. The weighted rating score for each rating sub-parameter is then computed by multiplying its weight with its rating score. iv. The total weighted rating score is then arrived at by calculating the sum of the sub-parametric weighted rating scores and
rounding it off to the nearest integer.
v. Using the DCRA’s Look-up Table, the rating equivalent to the total weighted rating score is arrived at. vi. This rating can be deemed to be the model implied rating.
vii. Model implied rating may be adjusted with sector-specific issues and deemed to be the final rating.
26. Once the broad rating category has been determined for each sub-factor, it could be converted into a numerical equivalent, as per the conversion table presented in Table A2.3:
Table A2.3: Conversion of Factor Ratings into Numeric Values
Rating Categories SME1 SME2 SME3 SME4 SME5 SME6 SME7 SME8
Notches 1 2 3 4 5 6 7 8
27. The eight rating categories span the full rating spectrum from SME1 to SME8. Each specific rating is mapped to a numeric equivalent, using a simple linear scale (e.g., SME1 = 1, SME8 = 8). Upon converting each sub-factor’s rating category into a number, it can be multiplied by the sub-factor’s scorecard weight, providing a weighted average of all the sub-factor ratings. E. Deriving Ratings through the Scorecard
28. Table A2.4 depicts an illustrative scorecard for SME ratings. Corresponding to the rating factor in the left most column the actual position of the SME being rated is provided in the Input column. From the conversion table, input description and numbers are mapped and a raw score is calculated. In the last column, the raw score is multiplied with the corresponding weight and finally model implied rating score is derived.
Table A2.4: Rating Scorecard for a Small or Medium-sized Enterprise (for illustration only)
Rating Factors Input
Raw Score from Conversion Table (a) Weight in % (b) Weightage Score (c = a x b)
1. Operational and Business Risk Moderate 4 40.00 1.60
Premises, Product and Services, People Element, Purchasing, Protection, Procedures, Performance, Planning, Policy, and Processes
2. Environmental Risk Low 2 5.00 0.10
3. Financial Risk 35.00
Earnings and Stability
Sales Tk500 million 3 2.63 0.08
EBITDA Trends Increasing 2 2.63 0.05
Profitability EBITDA Margin 24.3% 1 2.63 0.03 ROA 4.5% 1 2.63 0.03 Liquidity Liquidity Index 270 2 2.00 0.04 Current/Quick Ratio 1.45 3 1.50 0.05
Working Capital Management
OI/NWC 24.0% 3 2.00 0.06
Sales to Working Capital Limit 1.45 5 2.00 0.10
Average Inventory Period 90 4 1.00 0.04
Average Collection Period 120 5 1.00 0.05
Average Payment Period 30 2 1.00 0.02
Leverage and Net Worth
Debt/EBITDA 0.45 2 3.50 0.07 D/(D+E) 0.65 2 3.50 0.07 Coverage EBIT/Interest 2.5 3 3.50 0.11 DSCR 1.9 3 3.50 0.11 4. Management Risk 20.00
Promoter’s Track Record and Qualification Good 3 8.00 0.24 Management Quality and Succession Planning Moderate 4 6.00 0.24 Administrative Setup and Delegation Culture Weak 6 6.00 0.36
Model Implied Score 3.43
Mode Implied Ratings SME3
D = debt; DSCR = debt service coverage ratio; E = equity; EBIT = earnings before interest and taxes; EBITDA = earnings before interest, tax, depreciation and amortization; OI/NWC = operating income/net working capital; ROA = return on assets.
29. The model implied score of 3.43, which was derived by using the above scorecard, is then mapped to one of the eight ratings using the factor numeric table (Table A2.5), producing the final scorecard derived rating (model implied rating) of the SME, which is SME3.
Table A2.5: Factor Numeric Table of Small and Medium-sized Enterprises; 8-Notch Rating Scale (for illustration only)
>= <= Ratings 1.00 1.49 SME-1 1.50 2.49 SME-2 2.50 3.49 SME-3 3.50 4.49 SME-4 4.50 5.49 SME-5 5.50 6.49 SME-6 6.50 7.49 SME-7 7.50 8.00 SME-8
30. The ratings on SMEs reflect the overall creditworthiness of the rated units, adjudged in relation to other SMEs. These ratings are unit-specific, and not related to bank loans or debt issuances.
31. The objectives of assessing SMEs and corporate rating are not identical. Credit rating of SMEs does more than provide credit information. It creates greater awareness among SME entrepreneurs and managers and builds their knowledge and capabilities in identifying business lacunae and addressing them. In addition to easing access to finance for SMEs, credit rating can, in the medium to long term, be expected to lead to sector growth and inclusive development of the economy.
32. Advantages of undertaking SME ratings for various stakeholders are as follows:
(i) For individual SMEs. Create awareness about credibility and creditworthiness of SMEs leading to credit discipline and transparency.
(ii) For commercial banks.
Increase awareness among commercial banks about automated credit origination, data processing, approval, risk administration, minimization of credit assessment cost, and timely risk status reporting to management with their banking business. Enable migration from an individual’s opinion-based credit review process toward a
systematic and scientific process with emphasis on objective inputs.
Ensure a shift towards faster and more accurate, uniform, and timely credit decisions, wherein risk is properly managed
(iii) For DCRAs. With the development of an overall rating culture among SMEs as well as commercial banks, DCRAs will have the incentive to cater to this segment through objective, independent, transparent, and credible methodology.
(iv) For policy makers. An appropriate rating report allows an SME to compare its performance at a local, regional, and even global scale while establishing its overall position within the sector. Ratings of SMEs taken together can facilitate better and more targeted policy making that can give refined focus to the segment instead of a one-size-fits-all approach.
(v) For the SME segment. Overall, SME financing opportunities will expand, investment quality in SMEs will improve, and competitive market for SME ratings will emerge in Bangladesh.