Two terms that may seem straightforward and therefore easy to remember, understanding debtors and creditors is one of those tricky conundrums accounting can throw up now and again.
So, we’ve called on the help of one of our accountants in London, Riaz Kala, to help you navigate these terms once and for all and answer the questions, “What is a creditor?”, and “What is a debtor?”
It’s vital as a business owner that you understand debtors and creditors, and the role they play in the overall performance of your business.
Simply put, a creditor is an individual, business or any other entity that is owed money because they have provided a service or good, or loaned money to another entity.
As a business owner, there are two types of creditors you’re likely to be dealing with on a regular basis - (i) loans and (ii) trade creditors.
Firstly, an example of a creditor from the “loans” cohort above is, of course, a bank.
In fact, banks and financial institutions are the most prominent creditors in today’s economy. As these entities loan businesses money to finance their ventures - be it expansion, or otherwise - they become creditors as those businesses are required to repay to money borrowed.
Following on from that, a trade creditor is an entity which has supplied the materials used in producing a product. For example, a brick supplier would be owed money from a building contractor as they has supplied the bricks used to build a project.
Depending on your own business and how your model works, you may find yourself as being a the creditor to a debtor.
A debtor is an individual, business or any other entity that owes money to another entity because they have been provided with a service or good, or borrowed money from an institution.
There are two types of debtors to be aware of as a business owners - (i) staff loans and (ii) trade debtors.
An example of a debtor is a haulage company who borrows money from a bank to invest in a new fleet of vehicles. They become a debtor at the point of borrowing as the company will subsequently owe the borrowed money and any interest to the bank.
A staff loan is a preferential loan given to an employer by an employee, usually when the interest on said loan is lower than the specified interest rate in financial institutions.
Meanwhile, an example of a trade debtor is a software service provider who hasn’t been paid by their customers yet and is therefore owed money.
Depending on the nature of your business you may find that you have both debtors and are, yourself, a debtor.
Customers who do not pay for products or services up front, for example, are debtors to your business, which serves as the creditor in this scenario.
Similarly, you are in debt to your suppliers if they have provided you with goods which you are yet to pay for in full.
The relationship between the two terms is important, particularly in the case of small businesses as they affect assets and liabilities on your balance sheet and your business’ cash flow.
Being a creditor for another business can be considered an asset, demonstrating financial strength to your business, whilst excessive debt counts as a liability.
Striking the sweet spot between these is where many businesses operate successfully. On the other hand, failure to do so can see many smaller businesses, in particular, come to a premature end as a result of cash flow issues.
Debtors and creditors work in tandem in everyday life, potentially a lot more than you realise.
Take a bank’s company credit card service for example.
A business customer of the bank signs up for the credit card because they want to throw an end-of-quarter celebration for their staff and go all out with a catering service.
The business owner signs the contract for the card and proceeds to spend £2,000 on catering for their big blowout. At that point of spending, the business owner becomes a debtor, owing money to the bank for borrowing £2,000 on credit, plus interest.
At the same time, that business owner is a creditor of the bank’s because they have loaned the owner money that has yet to be repaid.
So, there you have it - a guide to everything you need to know about creditors and debtors.
At Accounts and Legal, we pride ourselves on being an accountant that cuts out all the jargon and speaks your language. This ensures that you understand the mechanics of your finances, thus enabling efficiency and stability while you grow your business.
If you need advice or services on any aspects of accounting, tax, business management or specific problems with debtors or creditors, our specialist team are ready to help. Please get in touch with us, or try our instant accounting quote tool and get a competitive fee in just 5 clicks.