Creditors and debtors explained

finance

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Creditors and Debtors might seem like simple terms, and on the face of it they are, but the practicalities of how the two terms can be applied can quickly become confusing, this is mostly the case if you are a small business. As with many financial terms it’s easy to get them confused, so it’s important to clearly understand the difference.

What is a debtor?

At it’s most basic, a debtor is a party that owes money to another party. Who that party is can vary dramatically? It can be a single person, it can be a small business, it can be a big business, it can even be a government. If money is owed, the party owing that money is known as the debtor – they have the debt. Money is loaned, usually in a lump sum. Repayments are then made over a pre-determined period of time until the loan is paid off. Usually, in addition to the value of the loan, there will be interest in addition. This is where the incentive comes to loan money: the interest can be considered profit on the transaction. It’s quite possible to be a debtor and to have debtors at the same time, particularly as a small business.

What is a creditor?

A creditor is the party who has loaned the money to the debtor. It doesn’t have to be cash: a loan can comprise anything that has perceived or practical value, for example, stocks, or equipment. Creditors are generally comprised of banks, building societies, and other financial institutions. However, there is a rising trend for alternatives, such as peer-to-peer lending. There may be other businesses or even government institutions that might lend to businesses. The term “creditor” is not exclusive to any one particular field or institution. It’s very possible that you, as a small business, might find yourself being the creditor to a debtor.

Pro and cons of Debtors & Creditors

Products and services may often be prohibitively expensive to pay for up front, or in one lump sum. Financing allows an individual or business to have use of the asset while paying for it in more manageable installments – often weekly, monthly, or sometimes quarterly. The benefit for the debtor is that they get access to funds or equipment that would otherwise be beyond them. This allows them to continue to build their business, so in some sense, the loan could be considered an investment in a business’ own ability to grow. The drawback is that a debt is considered a business liability, and non-payment may result in further penalties and potentially even legal action. The benefit for the creditor is that to be able to make a loan is the sign of a healthy and thriving business. There is also profit to be made in the form of interest paid on every loan repayment – so the ultimate amount paid back will be more than what was borrowed. The drawback is there is potential for non-payment, forcing the creditor to pursue potentially expensive legal proceedings to get what they’re owed.

Clear House Accountants recognize the hard work involved in understanding the various accounting and business terminologies involved in running a business. We have worked hard to create highly effective and concise guides and systems which will make this process easy for you, thereby helping you to understand complicated processes faster, enabling you to run and grow your business effectively. If you are looking for any advice or are stuck at some point in your business, please do not hesitate to contact us.