There are various ways to measure credit strength, which then get translated into a credit rating. There are a few standard ways, such as coverage, leverage, liquidity, solvency ratios. But you should also look at profitability, cashflows analysis, debt maturity schedules, even industry growth can be helpful.
Coverage Ratio: Coverage ratios mainly look at whether you have sufficient capacity to meet your interest obligations or coupon repayments. Your numerator could be EBITDA, or "EBITDA-CAPEX", and your denominator could be interest expense. Another good way to analyse this is the the Debt Service Coverage Ratio, which is Net Operating Income / Debt Service.
Leverage Ratio: Most notably, Debt/Equity. This shows how much of the firm's capital structure is financed by debt or equity. The higher this ratio, the more credit risk it has, since there is more debt to pay-off.
Short-term Liquidty: A good measure of this would be current ratio, which is just current assets over current liabilities. This measures where the firm can pay back its obligations in the short term (typically a year)
Profitability: This is quite intuitive, but also because principal repayments are not included in interest expense, there must be a net balance of cashflow after operating expenses to pay off the debt.
Cashflow Analysis: Most notably, your operating cashflows, to see if there is enough cashflow after your operating activities for principal or interest payments. The notion here is that you need enough cashflow to sustain your business before you can pay off your debts.
There are various ways to measure credit strength, which then get translated into a credit rating. There are a few standard ways, such as coverage, leverage, liquidity, solvency ratios. But you should also look at profitability, cashflows analysis, debt maturity schedules, even industry growth can be helpful.
Coverage Ratio: Coverage ratios mainly look at whether you have sufficient capacity to meet your interest obligations or coupon repayments. Your numerator could be EBITDA, or "EBITDA-CAPEX", and your denominator could be interest expense. Another good way to analyse this is the the Debt Service Coverage Ratio, which is Net Operating Income / Debt Service.
Leverage Ratio: Most notably, Debt/Equity. This shows how much of the firm's capital structure is financed by debt or equity. The higher this ratio, the more credit risk it has, since there is more debt to pay-off.
Short-term Liquidty: A good measure of this would be current ratio, which is just current assets over current liabilities. This measures where the firm can pay back its obligations in the short term (typically a year)
Profitability: This is quite intuitive, but also because principal repayments are not included in interest expense, there must be a net balance of cashflow after operating expenses to pay off the debt.
Cashflow Analysis: Most notably, your operating cashflows, to see if there is enough cashflow after your operating activities for principal or interest payments. The notion here is that you need enough cashflow to sustain your business before you can pay off your debts.