SHORT TERM INSTRUMENTS

Short Term Instruments

Background:

The framework of CARE‘s rating methodology essentially consists of analyzing the operational and
financial characteristics of the issuer. Besides quantitative factors, qualitative aspects like
assessment of management capabilities play a very important role in arriving at the rating for an
instrument. The relative importance of qualitative and quantitative components of the analysis
varies with the type of issuer. Rating determination is a matter of experienced and holistic
judgment, based on the relevant quantitative and qualitative factors impacting the credit quality
of the issuer.

Rating Criteria for Short Term Instruments:

CARE’s approach for rating a short term debt instrument is similar to the one followed for
assessing credit risk for long term instruments.

Though the time horizon of a short term instrument is upto one year, the time horizon for
arriving at the rating normally extends beyond this period since the attempt is to arrive at
ratings which do not change frequently.

Assessing liquidity and financial flexibility of the issuer gains more prominence while arriving at
short term ratings apart from the basic fundamental credit analysis of an issuer.

Liquidity:

Analysing liquidity is crucial for arriving at the short term rating. This involves analyzing the cash
flows, working capital management and examining the availability of any unencumbered liquid
investments or unutilized lines of credit from banks. Company’s cash-flows are examined to
assess the liquidity sources for repaying short term debt. The assumptions underlying the cash
flow projections are analysed to make a realistic assessment of short term liquidity.
Examination of asset liability maturity profile becomes important for assessing the liquidity
position of companies in the financial sector.

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Short Term Instruments

Financial flexibility:

Financial flexibility refers to alternative sources of liquidity available to the company as and when
required. While low level of leverage provides basic flexibility to raise additional borrowings,
alternative sources of liquidity can be:

a) General line of credit from strong parent or group company;

b) Strong group profile which could implicitly mean the possibility of group support in times of
stress;

c) Back up lines of credit from banks etc. Short term debt issued in the form of Commercial
Paper (CP) is often carved out of the working capital limits of the company thus implicitly
creating back-up liquidity facilities. Though this type of arrangement reduces the chances of
default in repayment of CP, it does not fully eliminate it. Inability or unwillingness of the bank
to restore the limits or shortfall in drawing power could lead to inadequacy of backup liquidity
at the time of CP maturity. Extent of utilization of working capital facilities and likely variation
in drawing power is hence studied in detail to assess the nature of cushion available.

Implementing large projects usually involves periods of strain on a company’s liquidity position. CARE
analyses factors like financial closure, stage of the project, draw down schedule of funds and the
various milestones of implementation of capital expenditure programme. In this context, flexibility to
defer capital expenditure or implement project in phases eases the strain on liquidity of the company
and thus provides comfort in terms of financial flexibility.

End Note: Short Term – Long Term Link

Even though weighed by short term factors which may tend to skew the short term rating, the long
term credit quality assumes a pervasive role in determining such short term ratings. A company with a
favorable long term fundamentals will find it much easier to fulfill its short term commitments on
account of its strong operating cash flows and its ability to leverage upon its strengths to refinance, if
required. This implicitly establishes a link between long term and short term ratings. Moreover, many
of the short term instruments tend to get ‘rolled over’, and though short term by design, they virtually
behave like long term instruments. In the eventuality of the company not being able to rollover the

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short term instrument, it may have to leverage its long term rating to get funds in the absence of any
other short term funding sources. Thus, a company’s long term credit quality cannot be ignored while
assigning short term ratings.

[Last updated on December 28, 2016. Next review due in April-June 2018]

Disclaimer
CARE’s ratings are opinions on credit quality and are not recommendations to sanction, renew, disburse or recall the concerned
bank facilities or to buy, sell or hold any security. CARE has based its ratings/outlooks on information obtained from sources
believed by it to be accurate and reliable.
CARE does not, however, guarantee the accuracy, adequacy or completeness of any information and is not responsible for any
errors or omissions or for the results obtained from the use of such information. Most entities whose bank facilities/instruments are
rated by CARE have paid a credit rating fee, based on the amount and type of bank facilities/instruments.

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