Random credit ratings put firms at risk
Providing agencies with company accounts can prevent the poor reports that send small firms to the wall, writes Michael Glackin
Michael GlackinPublished: 6 September 2015
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James Hill was working at his desk in his company's headquarters on the outskirts of Dundee one morning last summer when the telephone rang. The caller was one of Hill's suppliers. It wasn't an unfriendly call, but the supplier had some devastating news that heralded the start of a nightmare which almost sent Hill's successful business to the wall.
Hill's family-run firm, Protective Supplies and Procurement Services, provides safety equipment for the oil and gas industry. The £500,000-a-year turnover company has been in business for 20 years, survived the recession and, aside from a small overdraft at its bank, is debt-free.
However, the supplier had called to tell him that a routine credit check on Protective Supplies had revealed the company was "high risk", and from now on Hill would have to settle all bills in advance, before delivery.
"I was flabbergasted. Our profits had been increasing annually and I had been doing business with this supplier for five years without a single problem," he says.
After some detective work, Hill discovered that the commercial credit reference agency Experian had downgraded Protective Supplies’ credit rating to just 15/100 with an advice note to firms not to advance credit to the business.
"A year earlier we had a 93/100 credit worthiness score with Experian and a £7,500 credit limit," explains Hill. "Nothing in our business had changed, except we were busier than ever. I had no idea why we suddenly had such an appalling rating because we still had an 80-plus rating with the other commercial credit reference agencies. It seems to me that a credit rating is more pot luck than pure science. There was absolutely no reason for my firm to be downgraded."
Thousands of small and medium-sized businesses rely on commercial credit reference agencies (CRAs) to prove their viability to clients, suppliers and banks. They also rely on these credit ratings to decide whether to transact business with other companies.
However, more and more companies, particularly small businesses, are questioning the accuracy of the information provided by CRAs.
Hill's experience, which saw his company's credit rating slashed to "maximum risk" by Experian while other credit reference agencies groups deemed it as safe, is not unique.
A report published earlier this year by accountancy practice Shelley Stock Hutter (SSH), which analysed 100 private companies' credit reports, found three of the biggest commercial credit reference agencies — Creditsafe, Dun & Bradstreet and Experian — regularly recommended vastly different credit limits for the same companies.
The report, published in January, revealed the difference between the highest and lowest average rating of the three agencies for the 100 companies was 150%.
SSH found that one company had three credit limits which ranged from £1.5m to £4.9m, and another ranged from £0 to £18,000 with a rating of 4/100 to 83/100.
Part of the problem lies in the unique algorithms different agencies use to compile their individual ratings.
Each agency holds differing levels of data, which can produce widely differing results when it comes to assessing a firm's credit worthiness.
The Business Information Providers Association (BIPA), an industry group to which the main UK commercial credit reference agencies are affiliated, says credit reference agencies "are independent of each other and all use different data with different methodologies and models of assessing risk to create credit ratings or credit scores". It adds: "This can, of course, sometimes provide different outputs."
But the real problem is transparency. While CRAs are regulated by the Financial Conduct Authority, there is no regulatory control over how a company's credit rating is compiled. Each agency has a unique formula for rating businesses but, generally speaking, agencies use information that is publicly available from Companies House; the Registry Trust, the official database for court judgments, including county court judgements; the London, Edinburgh, and Belfast Gazettes; and the Office of Fair Trading.
Agencies correlate this information with their own intelligence. However, they jealously guard their formulae for rating businesses and most, with the exception of Experian, appear reluctant to discuss how they calculate figures.
There is also no sector-wide ombudsman with whom businesses can lodge complaints.
Andy Willox, Scottish policy convenor for the Federation of Small Businesses (FSB), says: "Some firms have been frustrated when they've tried to correct an erroneous record. That's why it is so important these decisions become more transparent and businesses are supported in understanding how they are made."
Bobby Lane, head of business development at SSH, says the current situation is ludicrous. He says the SSH report revealed Experian had given a small company a credit score of 83/100 in 2014 and recommended a credit limit of £18,000. But Dun & Bradstreet had given the company 4/100 and said that no credit should be given without guarantees.
Credit reference agencies argue that the discrepancies are often caused by the scarcity of financial information available on private companies.
The government's much-trumpeted attempts to cut red tape for small businesses has allowed many to file what are often incomplete or abbreviated accounts with Companies House. The Treasury has also resisted calls to place late payer information on national insurance, held by HM Revenue & Customs, into the public domain. Consequently, up-to-date information on firms is often extremely limited.
However, despite the paucity of information available on small firms, some still feel credit agencies should be more transparent.
Lane says: "I believe the agencies should be more open about their methodologies and perhaps carry a health warning that explains that the rating or limit is calculated based on their formula and the information they have available, and that there could be differences between different agencies."
However, he adds that companies need to do more to help themselves. "The more information that is available in the public domain the more information there is to make a more accurate assessment," he says.
That is borne out by Hill's experience. "I contacted Experian and asked why they were misrepresenting my company's financial position, but they told me they couldn't discuss the issue as I wasn't a customer," he says.
"Eventually, a couple of months later and after several emails between myself and Experian I decided to send them my business accounts and they immediately put the company's credit rating score back up to 83/100, but frankly by that time the damage had been done.
"I really feared I could lose my business. I spent weeks phoning and reassuring suppliers and customers. The whole thing took a lot out of me in terms of cash and time, and caused a lot of stress. I had to put my own money into the business to cover the upfront payments. I cashed in an ISA. I couldn't invest in the business because I was using all my spare cash to pay suppliers."
An Experian spokesman said: "We are unable to comment on this individual case, but we help thousands of businesses manage their commercial credit scores, so they are seen in the best possible light by lenders. We encourage them to check what information is held about their business before applying for credit and we work hard to resolve queries swiftly when a company asks for its credit score to be reviewed."