One of the most important things that you must do as a business owner is keep track of your financial situation. Even in the good times, it’s sensible to be aware of where every penny and pound is tied up. This isn’t just about making sure you can cover any unexpected bumps in the road, it’s also helpful when looking at the cost of new growth opportunities. A big part of staying on top of your finances is knowing the fundamental difference between your debtors and creditors.
Even in one business, the two terms don’t have to be mutually exclusive; you could be a creditor and a debtor at the same time. For the sake of effective accounting or simply for your peace of mind as a business owner, this guide will help you understand what each term means and the main differences between the two. Hopefully, that knowledge will put you in an even stronger position to build your business, so let’s start by looking at ‘debtors’ and its meaning.
What are debtors?
In short, debtors are individuals or organisations who owe money and need to pay it back at a later date. That date doesn’t have to be specified, nor does the debt need to be a specific item. As a business, you might purchase goods or services from another but are yet to settle what you owe. But it can also be where you decide to take on a form of debt financing.
As a debtor, the nature of what you owe will differ depending on what it’s for. If you’ve applied for debt financing, the chances are that you’ll be required to pay back what you owe through a series of monthly payments. For other debtors in a balance sheet, there may be a lump sum to be repaid. Don’t forget that you may also need to pay interest on the amount of debt you owe.
What is the debtors recovery process?
In some situations, a debtor may not be able to meet their obligations in terms of paying back what they owe. Of course, there are many reasons for that. Maybe it was a genuine oversight, or perhaps the financial situation of a business is more perilous than first thought. Either way, it’s reasonable to expect that a lender or supplier will take steps to secure what they’re owed.
If you find yourself in this position, the important thing to note is that you may be able to ask your creditor (explained below) for breathing space. There are also many options a supplier or lender can take too. If you have a credit line, it could be stopped until payment is made. A reminder or final notice could be issued. Ultimately, legal action could be taken against you.
What are creditors?
Put simply, creditors are the opposite of debtors. Rather than owing money, you (as a creditor) are owed an amount that you have either advanced or loaned to another. For business owners, this is most likely going to involve the supply of goods or services. There may well be situations when, like financial institutions, that amount owed is in the form of a loan or line of credit.
A provider of commercial funding products to SMEs is one example of a creditor. You may be provided with the finance you need to grow before you then repay it over time under the terms of our agreement. Of course, your business could also be a creditor. And the type of creditor can sometimes determine who gets paid and when.
Are there different types of creditors?
In short, yes – creditors can be categorised into different types. Some examples are:
- Real creditors: A term given to banks or other financial providers who provide funding to businesses. This funding could be secured or unsecured.
- Secured creditors: If you take out a secured business loan, for example, the creditor has a legal right to take ownership of collateral when the amount is unpaid.
- Unsecured creditors: It depends on the situation and the purpose, but creditors can offer finance that doesn’t require security (e.g. property) to be put forward.
- Trade creditors: As a business, this may be a common form of creditor you come across. It can be a service provider or product supplier that’s yet to be paid.
- Preferential creditors: Under the Insolvency Act 1986, these creditors get priority in the event of a debtor being liquidated. HMRC is one such preferential creditor.
As the above suggests, there is a set order in which different types of creditors can claim back what they’re owed if the worst happens and a debtor is liquidated.
What is a Creditors Voluntary Liquidation?
If you’re a creditor that hasn’t been paid, there are circumstances in which you can apply to the courts for a winding-up order. If accepted, the party that owes you money will be liquidated. By doing this, its assets are distributed to creditors owed money. This is known as ‘compulsory’ liquidation, as the party issued with a winding-up order must abide by a judge’s eventual decision.
An alternative to this, however, is a Creditors Voluntary Liquidation. This is where directors and shareholders can choose to place their company into liquidation to pay its debts. The aim is still the same in that creditors are paid what they’re owed through the redistribution of assets. That said, the order in which creditors are paid will still apply, i.e. secured and preferential ones first.
What is the difference between debtors and creditors?
There is one fundamental difference between debtors and creditors. As a debtor, your company owes money to another. As a creditor, meanwhile, you are the one that is owed. Based on what type of business you are, it’s entirely possible that you can be both at the same time.
You could be, for example, a clothes manufacturer. On the one hand, you may have a retail partner who sells your products and owes you for your latest consignment. This makes you a creditor. But, on the other hand, you may have taken out a business growth loan to expand your current operations. Doing so then makes you a debtor to the bank or alternative funding provider.
No matter what status you hold, it’s essential to note your debtors and creditors in your balance sheet. Losing track of what you owe and what you’re owed can make it very difficult to stay on top of your finances. It can also stop you taking advantage of any growth opportunities.
Get clarity for your business
Getting to grips with the ins and outs of financial terminology can lift you to the next level whenever the next opportunity emerges. Why not get in touch with a member of the Pulse team for more support or if you’re ready to start seeing things more clearly, sign up for game-changing insights. To browse other topics online, visit our blog hub and become a business whizz.
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