Who is a Debtor and who is a Creditor?
A debtor is a person or an enterprise that owes money to some other party. A debtor is a person or enterprise that owes money to another party. Conversely, a creditor is a person, enterprise or bank who has lent money or extended credit to another party. The other party may be a bank, some other lending institution, an enterprise or a supplier among other. The party supplying or lending the money is called creditor. In other words, a creditor is an entity or a person that extends credit to another party. A debtor on the hand is the person or entity to whom the money is lent. What it means is that any type or form of lending arrangement is going to have two parties involved referred to as creditor and debtor. For example, if company Zulu has borrowed money from the bank INS, then company Zulu is the debtor and the bank INS is the creditor. If part of the money borrowed from bank INS by Zulu is lent to an enterprise DEK, in that scenario Zulu is now the creditor and DEK is now the debtor.
Organizations in their normal course of operation often borrow money from bank and other institutions. They also sell goods on credit. This creates a debtor and creditor relationship between the parties involves. As mentioned above, debtors are the one who owe money or have brought goods on credit from other party. Creditors are the parties who sold the goods on credit or who have lent money to other party. Both the debtors and creditors play an important role in working capital management of the company. Debtors are an integral part of current liabilities and represent the total amount owed by it to the business. On the other hand, creditors represent trade payables and are part of the current liability. The term debt and credit are also important as they affect the assets and liabilities on your balance sheet.
Difference between Debtor and Creditor Explained
Debtors and a creditors share a crucial relationship when it comes to the extension of credit between parties and the related transfer of assets and settlement of liabilities. However, it is important to note that there is the role or action of a creditor is different when it is ’lending money’ versus when it is ‘extending credit’. These differences are enumerated as following:
When it comes to lending, it is not uncommon for creditors to ask for loan covenants, collateral or personal guarantee. This is because the sum involved is often large and the credit is extended for lengthy period of time. The creditor as such needs to cover the risk of lending substantial money and hence some type or form of guarantee is required. Another point to note is that creditors in the business of lending money in majority of cases may be solely in the business of lending money.
When it comes to extending credit, please note that money is lent on a short term basis and the sum involved is also not as large as is the case with lending money. The party extending the credit as such is more concerned with the line of credit granted and payment terms rather than personal guarantees or collaterals. Covenants are extremely rare in case of trade credit. An entity that extends credit may be in the business of selling goods and services. Sometimes organizations also extend credit to remain competitive in the marketplace as in absence of such facility; a retailer or wholesaler may buy from its competitors who are willing to extend credit.
From above example, we can easily make out that lending of money is usually carried out by banks and similar other financial institutions whereas credit is generally extended by businesses in their normal course of operation. It is also important to note that businesses generally are both creditors and debtors. They assume the role of creditors when they sold goods or services to their customers on credit and become debtors when they pay their suppliers on delayed payment terms. An all cash transaction with full settlement may be the only case where no debtors or creditors are created. For example, if PRY Company lends money to BRY Company, PRY takes on the role of the creditor, and BRY is the debtor. Similarly, if BRY Company sells goods to PRY Company on credit, their role is reversed and in this case PRY Company is the debtor and BRY Company is the creditor.
Debtors V/s Creditors: A Comparison Chart
|Basis for Comparison||Debtors||Creditors|
|Meaning||Debtors are the parties who owe money.||Creditors are the parties to whom the money is owed.|
|What is it?||It is an account receivable.||It is an account payable.|
|Discount||Debtors are allowed discount||Creditors give discount|
|Where the two words are derived from||Debtor owes its origin to Latin term ‘debere’ which means ‘to owe’.||Creditor owes its origin to Latin term ‘creditum’ which means ‘to loan’.|
|Provision for doubtful debts||Created on debtors||Not created on creditors.|
Line of Credit
In business a Line of Credit s an arrangement/commitment entered into by a bank or a creditor with its customer wherein it is mentioned the amount of money the customer can borrow or use in the future given certain specific financial conditions are met. For example, a customer may make an arrangement with the bank to borrow money as and when the need arises but the borrowed sum may never exceed more than 200000 pounds. In the United States it is a common practise where line of credit is generally extended in case of purchasing homes.
Definition of Debtors
As previously mentioned, debtors are parties who owe money to a company, a bank, financial institution, an enterprise, etc. Whenever a company sells its goods or services to a buyer, the buyer is considered to be a debtor and the company is considered to be creditor. An important thing to note is that debtors are current assets of the company and shown under the head ‘trade receivables’ on the balance sheet of the firm. Current assets mean they can be converted into cash within a year.
A company’s decision to offer credit to a person hinges on many factors like the person’s credit history, reputation, financial condition, etc. The decision to offer credit, duration of the credit and any incentives that may be offered for early payment of debt is decided by the top management of the company. The debtors may be charged an interest as penalty in case of late payment of debt.
Early payment discount
An early payment discount, also known as prompt payment discount or cash discount is the discount paid to the debtors in order to motivate them to pay sooner. For instance, a company that sells on credit may offer credit terms such as 1/15, net 30. What it means is that the debtor will get a discount of 1 per cent if the debt is paid within 15 days instead of the stipulated 30 days. In other words, the debtor enjoys 1 per cent discount if he pays 15 days early.
Definition of creditors
Creditors are parties like lenders, government, suppliers, service providers, etc to whom the debt is owned. In your normal line of business operation you may be both a debtor and a creditor. A company offering its goods, money or services to another party on promise of deferred payment is called a creditor. As debtors are current assets of the company, creditors are current liabilities of the company whose debt is to be paid within one year. The tag current liabilities are applied because the debt is of short term duration and needs to be repaid shortly. The debtors must pay their debts within the specified period in order to avoid interest charges as penalty. Creditors are current liabilities of the company and shown under the head ‘trade payables’ on the balance sheet of the firm. Creditors can be divided into following categories.
These creditors have first right to debt repayment. Secured creditors provide debt after some collateral is provided.
Unsecured creditors are those who provide debt without any security backup
They enjoy precedence over unsecured creditors when it comes to debt repayment. They are tax authorities, employees, etc.
Key Differences between Debtors and Creditors
Customers who do not pay upfront in full for your products or services are debtors to your business, and you are the creditor here. Similarly, you are the debtor to your suppliers if do not pay upfront in full for their goods or services.
The major differences between debtors and sundry creditors are summed up as following:
- Debtors are the parties who owe a sum of money. Creditors are the parties, to whom the sum is owed.
- Debtors are shown under the head ‘trade receivables’ on the balance sheet of the firm whereas creditors are shown under the head ‘trade payables’ in the balance sheet of the company.
- Debtors are the assets of the company while Creditors are the liabilities of the company.
- Debtor owes its origin to Latin term ‘debere’ which means ‘to owe’. Creditor owes its origin to Latin term ‘creditum’ which means ‘to loan’.
- In the case of Debtors, the discount is allowed by the company. On the other hand, in the case of Creditors, the discount is received by the company.
- Provision for doubtful debts is created on debtors, but not on creditors.
Recording Debtors and Creditors in Bookkeeping Accounts
Bookkeepers are required to acquire, record and protect for a company, person or enterprise all the relevant financial transactions entered into by them. All the financial transactions are recorded under double entry bookkeeping system and when we talk about debtors and creditors, they are entered as debit and credit under the double bookkeeping system. Debtors are recorded on the left side of the accounting system whereas creditors are entered on the right hand side of the account. The bookkeeper first and foremost creates the ‘chart of accounts’ during the process of creating the accounting system. This ‘chart of accounts’ will include a balance sheet which displays the financial position or strength of the client according to assets, liabilities and ownership interest. The balance sheet is followed by an income statement which lists the clients’ expenses, gains, income, losses and equity and as far as debts and credits are concerned, debts are expected to decrease liabilities along with income and equity and increase assets and expenses. Credit on the other hand is expected to increase liabilities along with income and equity and decrease assets and expenses. The bookkeeping system follows a double entry procedure where if one account is debited the other would have to be credited.