What Are Debtors and Creditors? A Guide for Businesses
Debtors and creditors are two fundamental parts of business accounting. Put simply, debtors are people or businesses that owe your company money, while creditors are people or businesses that your company owes money to.
Understanding the difference is important because both can directly affect your company’s cash flow, working capital and overall financial position.
What Is a Debtor?
A debtor is an individual or organisation that owes money to your business.
For many businesses, debtors are customers who have purchased goods or services on credit and have not yet paid their invoices.
For example, if your business completes £10,000 of work for a customer and gives them 30 days to pay, that customer becomes a debtor until the invoice is settled.
The outstanding £10,000 would normally be recorded within trade receivables on the company’s balance sheet.
What Is a Creditor?
A creditor is an individual or organisation that your business owes money to.
This commonly includes suppliers that provide goods or services to your business on agreed payment terms.
For example, if a supplier provides £5,000 of materials and allows your company 30 days to pay the invoice, the supplier is a creditor of the business until that amount is paid.
Amounts owed to suppliers would normally appear within trade payables on the company’s balance sheet.
What’s the Difference Between Debtors and Creditors?
The simplest distinction is the direction in which the money is owed.
Debtors owe money to your business.
Creditors are owed money by your business.
From an accounting perspective, trade debtors generally form part of a company’s current assets because they represent money expected to be received.
Trade creditors generally form part of current liabilities because they represent amounts the company is expected to pay.
How Do Debtors Affect Business Cash Flow?
A business can be profitable while still experiencing cash flow pressure.
If customers are given 30, 60 or 90-day payment terms, there can be a significant gap between completing the work and actually receiving the cash.
As the value of outstanding invoices increases, more of the company’s working capital can become tied up in its debtor book.
This is particularly relevant for growing businesses. Increasing sales can result in larger amounts being owed by customers, potentially increasing the amount of working capital required to support day-to-day operations.
How Do Creditors Affect Cash Flow?
Creditors can have the opposite effect.
Supplier payment terms allow a business to purchase goods or services without paying for them immediately. This can provide valuable breathing room between incurring an expense and making payment.
However, those invoices still need to be settled.
Businesses therefore need to understand when payments to creditors fall due and ensure sufficient cash is available to meet those obligations.
Effectively managing the timing of money entering and leaving the business is an important part of working capital management.
Managing Debtors and Creditors
Good debtor and creditor management starts with having clear visibility over what the business is owed and what it owes.
Businesses can improve this by maintaining accurate financial records, issuing invoices promptly, establishing clear payment terms and regularly reviewing outstanding balances.
Following up overdue invoices is also important. The longer an invoice remains unpaid, the greater the potential impact on cash flow and the higher the risk that payment becomes difficult to recover.
At the same time, maintaining good relationships with suppliers and communicating early where payment issues arise can help businesses manage their creditor position more effectively.
What Happens When Too Much Cash Is Tied Up in Debtors?
Businesses with substantial amounts outstanding from customers can experience a working capital gap.
The company may have generated revenue and issued invoices but still need to pay wages, suppliers, rent and other operating costs before those invoices are settled.
Depending on the circumstances, businesses may consider working capital facilities or invoice finance to help manage this timing difference.
Invoice finance, for example, can allow eligible businesses to access a proportion of the value of outstanding invoices before customers make payment.
Understanding Your Working Capital Position
Debtors and creditors should not be considered in isolation. Together with cash, stock and other short-term assets and liabilities, they contribute to the wider working capital position of a business.
Understanding how quickly customers pay, when suppliers need to be paid and how much cash the business requires to operate can provide a clearer picture of its short-term financial requirements.
For businesses experiencing working capital pressure or looking to support continued growth, Revia can help explore appropriate funding options from across our lender network.
