The FHR provides an estimated probability of default and is a measure of a counterparty's financial health. It is forward-looking and calculated using recent quantitative financial statement data only. Qualitative context about a counterparty, such as its growth plans, ownership structure, strategic contracts, or banking relationships, is not factored into the rating itself.
Financial health is a large component of evaluating the viability of a partnership, and we encourage you to use the FHR alongside other tools that provide different viewpoints. Below are the key guidelines for understanding what the FHR considers, why qualitative context is excluded, and how you can factor that context into your own assessment.
What Counts as Quantitative Data
Quantitative data is every data point contained within a counterparty's financial statements, including line items from the balance sheet, income statement, and cash flow statement. The model uses these inputs to calculate 68 financial ratios, which form the basis of the FHR.
If a value appears as a number on the counterparty's financial statements, the model uses it. If a situation or event is not reflected in the financial statements with a numerical value, its effect on the FHR cannot be predicted.
What Counts as Qualitative Context
Qualitative context is anything about a counterparty's business that is not expressed as a line item on its financial statements. Common examples include:
Growth narrative: the story behind a change in revenue, such as new product launches, geographic expansion, or expected market tailwinds
Age and size: how long the company has been operating and its relative scale within its industry
Access to capital: undrawn revolving credit facilities, strong banking relationships, or confirmed funding commitments
Strategic contracts and arrangements: long-term customer contracts, cash sweep agreements, exclusivity arrangements, or framework agreements
Ownership structure: private equity ownership, venture capital backing, family ownership, or employee ownership
Backing commitments: parent company guarantees, letters of support, or intercompany arrangements
These factors can meaningfully affect how you assess a counterparty's financial health, but none of them appear directly in the FHR.
Why the FHR Excludes Qualitative Context
Excluding qualitative context protects the qualities that make the FHR useful to you:
Objectivity: The FHR is an independent, third-party view of a counterparty's financial health. Weighing qualitative factors such as strong contracts or experienced management would require subjective judgments and reduce the value of the rating.
Consistency across companies: Every FHR is calculated the same way, using the same type of inputs. This allows ratings to be compared across industries, life cycles, company sizes, and both public and private companies, so you can compare a counterparty's rating against every other counterparty you work with.
Reliability of inputs: Financial statement data is prepared under recognized accounting standards and, in most cases, independently audited. Qualitative claims are not. Weighting them alongside financial data would treat inputs of very different reliability as equivalent.
How Qualitative Events Relate to Default Risk
In our experience, qualitative events such as legal action or scandals occur for companies across the risk spectrum but very rarely force lower-risk companies to default. This is partly because lower-risk companies that operate efficiently tend to quantify any event or situation that may have a material effect, for example through reserves on the balance sheet or specific cash flow expenditures. Once an event is reflected in the financial statements, it becomes part of the data the FHR uses.
How to Factor Qualitative Context Into Your Assessment
Qualitative context remains relevant to your assessment of a counterparty. The FHR provides the quantitative view, which you can pair with other sources of information:
Use the FHR as a conversation guide: Review the specific drivers behind the counterparty's score and discuss them with the counterparty. For example, a weaker ratio may be tied to a one-time event, a strong growth trajectory may not yet be reflected in the latest period, or a strategic contract may materially affect revenue stability. The Financial Dialogue report can support these conversations by identifying the most relevant financial issues facing a counterparty and suggesting questions to ask.
Monitor news: Use the News function on the preview page and set up News Alerts to gain insight into qualitative developments at a counterparty.
Review a counterparty's ActionPath: Counterparties can use ActionPath to record the strategies and targets they are pursuing and share the projected impact on their FHR before their official rating updates. ActionPath also allows counterparties to provide additional qualitative context about their plans and projections through a cover letter at the beginning of their ActionPath. The cover letter includes three sections:
Introduction
Summary of Business Strategy
Summary of FHR Projection
Reviewing this information can help you better understand the business context behind a counterparty's projected financial performance.
If you have specific questions about the FHR Report or the performance of a particular company, our team is happy to discuss the rating with you.