As consumers, we understand what ‘credit’ means. But in business many people confuse debtors and creditors.
Understanding the terms is essential if you run a business, so here’s what you need to know to get a grasp of what each word means.
What’s a creditor?
Creditors can be individuals, companies and other entities who are owed money for providing a service, goods or loaned money.
There are two types of creditors businesses tend to deal with: loan and trade. Loan creditors include banks and other financial institutions that lend money. Trade creditors, however, are suppliers that are still to be paid for the goods or services they’ve delivered.
For example, if you have purchased office furniture for your business and the invoice is still to be paid, the office supplies firm is classed as a creditor.
What’s a debtor?
Debtors are the exact opposite of creditors. These are individuals, companies or entities that are owed money for the goods and services they have provided.
For example, if you run a print business and have invoiced a company for printing brochures, that company is a debtor until they have paid their bill.
Debtors and creditors and your cash flow
Understanding the terms debtors and creditors is essential, especially for small businesses. This is because they affect a business’s assets and liabilities on the balance sheet as well as cash flow.
Keeping track of debtors means you’re more likely to get paid on time. This also means cash reaches your business account helping you pay your creditors within agreed payment terms. Failing to get a grasp on your debtors and increasing what you owe to creditors can lead to real problems in a business.
According to accountancy software company Xero, 50,000 businesses that fail annually did so because of cash flow problems. It says that often “the working capital they need is tied up beyond their reach with late paying customers”.
It shows that it is essential to understand the terms on your balance sheet and to keep tabs on your debtors.
How to reduce debtors
- There are many ways you can reduce the number of debtors in your business. You can:
- Only give credit to creditworthy customers
- Offer early payment discounts or rewards
- Keep on top of overdue invoices
- Put strong payment terms in place and stick to them
- Set up a process for chasing invoices that are overdue
- Keep accurate records
Maintaining accurate balance sheets and cash flow statements is essential. Together, they give an overview of your business’s financial position.
For help understanding more about debtors, creditors, cash flow and balance sheets, contact our team today for a free consultation.