As a business, you will have come across the concepts of debtors and creditors. It is vital to understand the role that these play in a business. Keep reading for our guide to the definition of debtors and creditors, how to manage either, and what the differences between the concepts are.
Definition of creditors
The term creditors refers to entities that capital is owed to because they provided goods or services to another party. Creditors can be individuals, businesses, or other types of entities. There are two types of creditors: loan creditors and trade creditors. The former refers to banks, building societies, and other financial institutions, whereas the latter describes suppliers that are waiting for payment for the goods or services supplied.
Definition of debtors
The term debtors refers to entities owing money to another entity because they received goods or services or borrowed money from a financial institution. Debtors can be individuals, companies, or other types of entities. The debt in question is a lump sum that can be paid in monthly instalments over a specified period until the debt is paid off. Debtors may also be charged interest on the original amount of the debt or loan.
How to manage debtors and creditors
Maintaining a positive relationship with those you owe money to is crucial. Also, try to avoid recurring payment delays as this might lead to reputational damage. As a debtor, you may also have to pay interest on the loaned money which can harm your working capital. This is why establishing a good accounts payable process is key if you have your own business. In general, try to negotiate longer credit terms, and build strong working relationships with suppliers.
If you are the entity money is owed to, it is crucial to managing your debtors. Clients falling behind with their payments can cause bad debt (= irrecoverable receivable). This would mean that the debt in question cannot complete the payment and you will eventually need to write it off. A key part of managing debtors and thereby improving positive cash flow is to improve your accounts receivable process. If your processes are set up well, it will be easier for you and your team to recover money borrowed by other entities. You could eg offer positive incentives for a client that owes money to pay earlier or think about streamlining your invoice workflow. Another way to avoid bad debt and ultimately cash flow issues is to establish a solid credit policy.
Difference between debtors and creditors
There are key differences between debtors/ creditors. In a nutshell, creditors are entities that are lending money to another company and are awaiting repayment of that owed money. Debtors, on the other hand, are entities that have borrowed money or received goods/ services from a business and therefore owe money.
Most businesses are both creditors and debtors. For example, businesses will often elect to extend credit and pay suppliers via delayed payment terms.