What is the Distinction between Debtor and Creditor?

Creditors and Debtors are an integral of every business. Buying and selling services or goods for credit changes the relationship between a buyer and seller to a Debtor vs Creditor. They assist the business run on credit cycles, so a business doesn’t feel any liquidity pressure in its everyday activity. Any purchase done on credit will be added in creditors on the current liabilities side of the balance sheet while every sale done on credit shall be added in Debtors to the present assets side on your balance sheet. Creditors vs Debtor are also important to find a credit policy for the organisation as they plan for the its liquidity over a particular period.

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Meaning of Creditor

A creditor is a person or institution that extends credit by giving another entity (person or institution) permission to borrow money intended to be repaid in the future. A business that gives supplies or services to a company or individual and does not demand payment in near future is also considered a creditor, based on the fact that the client owes the business money for services already provided.

Creditors can be categorized into either personal or real. People who give money to friends or family are personal creditors. Real creditors like banks or finance companies have legal contracts with the borrower, sometimes granting the lender the right to demand any of the debtor’s real assets like real estate or cars if they fail to pay back the loan.

Understanding Creditors

In simple terms creditors make money by charging interest on the loans they offer their clients. For example, if a creditor lends a borrower INR. 5,000 with a 5% interest rate, the creditor makes money due to the interest on the loan. In turn, the lender accepts a degree of risk in case the borrower may not repay the loan.

To decrease risk, most creditors scale their interest rates or fees to the debtor’s creditworthiness and past credit history. Thus, being a responsible debtor could save you a substantial sum, particularly if you are taking out a huge loan, like a mortgage. Interest rates for mortgages depends on  innumerable  factors, including the size of the down payment and the lender itself; however, one’s creditworthiness has a major impact on the interest rate.

Debtors with good credit scores are taken to be low-risk to creditors, and as a result, these debtors garner low interest rates. In contrast, borrowers with low credit scores are riskier for lenders, and they charge them higher interest rates to address that risk.

What Happens if Creditors Are Not Repaid?

If a creditor does not get repaid, they have a few different options. Personal lenders who cannot reimburse a debt may be able to claim it as a short-term capital gains loss on their income tax return, but to do so, they must make a significant effort to reimburse the loan.

Lenders such as banks can reclaim collateral such as homes and cars on secured loans, and they can take borrowers to court over unsecured debts. The courts may order the borrower to pay, garnish wages, or take other actions.

Creditors and Bankruptcy

If a borrower decides to declare bankruptcy, the court notifies the creditor of the proceedings. In some bankruptcy cases, all of the borrower’s non-essential assets are sold to repay debts, and the bankruptcy trustee repays the debts in order of their priority.

Tax debts and child support mainly get the maximum priority along with criminal fines, overpayments of federal benefits, and a handful of other debts. Unsecured debts such as credit cards are prioritized last, giving those lenders the smallest chance of reimbursing funds from debtors during bankruptcy proceedings.

Meaning of Debtor

A debtor or borrower is an individual or organisation that owes the money. In case the debt is in the form of a loan from a financial institution, the borrower is called a creditor, and the debtee is known as an issuer in the form of securities, like bonds. Legally, any individual who files a voluntary petition for bankruptcy declaration is often said to be a debtor.

Failure to pay a debt is not considered to be a crime. With the exception of such bankruptcy cases, borrowers may prioritise their debt repayments as they wish, but if they fail to uphold their loan terms, they can face fines and penalties, as well as a drop-off in their credit score. In addition, the lender can bring the debtor to the court regarding the matter.

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How Does One Become a Debtor?

The term ‘debtor’ refers to a person as well as other firms, like banks, lending companies, and more. If anyone owes payment for goods or services given to an entity or a company, the individual owing may be called a debtor.

Kinds of Debtors

In general, a debtor is a customer who has purchased a good or service and, therefore, owes the payment in return to the provider. Customers or suppliers are called debtors or creditors for accounting purposes.

‘Debtor’ means not only goods and services client but also to an individual who borrowed money from a bank or lender. For example, if someone take a loan to buy your house, then he or she is a debtor in the sense of borrower, while the bank holding his or her mortgage is considered to be the creditor.

Generally speaking, if an individual borrow money, then he or she is a debtor to the loan provider. Every borrower typically has a formal agreement with the lender (supplier/creditor) regarding terms of payment, discount deals, etc.

Debtors & Creditors explained in Business or Company Perspective

The nature of business concern is such that it allows them to  sell or buy to one other on agreed payment terms with cash exchanging hands at later dates; this is known as credit.

When a buyer and seller begin selling and purchasing products on credit, their relationship is re-termed as debtor and creditor.

What is a debtor?

A debtor or borrower can be an entity, company or a person of a legal nature who owes money to another party. A business or a person with one or more borrower is called a creditor.

In other words, the relationship that a debtor and a creditor share is complementary to that of a customer and supplier share. Anyone to whom an individual as a business have to lend in any way, including unpaid invoices on products or services provided to clients, are considered as his or her trade debtors.

Why do businesses need to keep an eye on their borrowers?

Businesses keep an eye on their borrowers because managing them in the right way ensures that they get paid faster, resulting in far fewer bad debts. In addition to this, collecting debtors’ accounts quickly ensure a healthy cash flow. Managing debtors are usually known as credit management and include the following –

• Timely debt collection
• Setting up credit limits and payment terms.
• Making credit checks as well as credit applications.
• Enforcing a clear credit policy.
• Considering debtor finance.

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What is a creditor?

A creditor or lender can be anyone from a bank, supplier or someone who has provided goods, money or services to a business or an individual with the expectation of being paid back at a future date.

A secured creditor is the one who has a registered lien on some of the businesses or individual’s assets. On the contrary, an unsecured creditor is the one without a lien on their assets.

Why do businesses keep an eye on their lenders?

Businesses keep an eye on their lenders for a various reasons. Knowing how much a company owes, how much the owed money, and when payments must be made or received lets them know their cash flow. It also ensures that they have enough money in the bank for business payments, such as salaries, rent, and other overhead expenses.

As we can see, businesses need to keep an eye on their lenders, mainly if their companies are seasonal, which means that they might need to pay suppliers several months ahead of their customers pay them.

Understanding debtor days and what are creditor days in business

The terms debtor days and creditor days are used to know  the average number of days that an organisation lets pass before its debtors pay and the average no of days a company lets give before its lenders are paid, respectively.

Creditor days are used to measure a its creditworthiness and reputation to a certain degree. Creditor days gives the scope allowed by its suppliers and creditors. It also reflects the value that both organization put on the business conducted and demonstrates the organization’s cash flow and the extent that it’ll go to finance its business with its debt.

Debtor days are used to indicate how efficiently an organisation invoices goods, services and collects from its customers. Fewer debtor days are good for a company. Payment delays tell the organisation that their customers have cash flow issues or are facing problems. Due to their size and power, such as big supermarket chains, they might be overstocked or held to payment by some of their customers. These types of customers usually fall victim to unpleasant credit terms and lower service levels.

How are creditor days calculated?

Dividing total debt by sales revenue and multiplying the result with 365 will calculate creditor days. A debt of INR 800,00 with sales revenue of INR 9 million will be calculated like this –

(800,00/9,000,000) x 365 = 3.244 creditor days

How are debtor days calculated?

Dividing the total outstanding debt by sales revenue and multiplying the result with 365 will calculate debtor days. Outstanding debt of INR 600,00 with a sales revenue of INR 9 million will be calculated like this –

(600,00/9,000,000) x 365 = 2.433 debtor days

Main Differences Between Creditors vs Debtors

Both Creditors and Debtor is a topmost and significant position in the organization. Let us discuss some of their major differences :

• Creditors are people or entities to whom the organisation has an obligation to pay a certain sum of money. Debtors are people or entities who owe a sum of money to the organisation.
• Creditors are Account Payable and reside under present liabilities in the Balance Sheet. Debtors are Account Receivable and reside under present assets in the Balance Sheet.
• Non-payment of dues to lenders affects the working capital cycle positively but negatively affects Credit status. Non-receipt from the Borrower’s affects the working capital cycle positively but does not affect Credit status.
• As a credit, it is easier to prescribe terms to the supplier on how much credit is required and the term thereof. As a debt, or it is comparatively not easy to inflictterms to a customer regarding the credit period and term thereof.
• Higher creditors have negative impact on the Working Capital and liquidity ratios where as the Higher Debtors have a good impact on Working Capital and liquidity ratios.
• There is no need for the creation of the provision of creditors. Provision of Doubtful Debt is required to be generated for Debtors according to the Accounting Policies.

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Creditor vs Debtor Comparison Table

Let’s look at some of the important Comparison between Creditors vs Debtors.

Basis of Comparison	Debtors	Creditors
Meaning	A individual who owes you money in exchange for goods sold or services rendered.	An individual who you owe money to in exchange of   services received or goods purchased.
What is it?	It is an account receivable.	It is an account payable.
Place in Financial Statement	It is an item in the Balance Sheet on the Asset side.	It is an item in the Balance Sheet on the liabilities side.
Benefit	It helps increase customers as normally they would prefer a credit purchase instead of cash.	It helps the organisation use the goods or services in advance to the actual payment date and thus enjoy a credit period before the actual payment.
Impact on Profit Margins	No impact on Profit Margins	No impact on Profit Margins
Impact on Cashflow	Negative impact on cash flow as the payment will be received at a later date.	Positive impact on cash flow as the payment is made at a later date.
Impact on Working Capital	High creditors will increase working capital.	High creditors will reduce working capital.
Impact on Liquidity Ratios	Yes, it will affect the current ratio.	Yes, it will affect both current  and quick ratio.
Provisions	Provisions of Doubtful Debts to be created as per Accounting Policies	No provisions to be made
Impact on Capital Structure	No impact on Capital Structure	No impact on Capital Structure

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Conclusion

For operating any business Creditor and Debtor are very important terms as most businesses run on credit. A business requires to have a great liquidity position. Ratios like the Current Ratio and the Quick ratio measure the current liquidity situation is of the organisation. Creditor vs Debtor is an essential part of the said, and they form an important part of the organisation’s liquidity position. A credit policy is made with specific reference to the credit period received or allowed and the amount received or given on credit so the institute can plan properly in advance regarding its credit cycle. It is essential to have a strong and robust credit policy in place, so the business does not get working capital stress.

Thus, Creditor vs Debtor is important for every company as they play a huge part in running the business and its liquidity situation.

Debtor and Creditor Quiz

1. A secured transaction usually involves

a) collateral

b) right of repossession

c) security interest

d) all of these

Ans (d) all of these

2. A security interest is an

a) interest in collateral.

b) interest on a federally insured bank loan.

c) interest paid on Social Security benefits.

d) interest you pay for security protection.

Ans (a) interest in collateral

3. When the net proceeds from repossessed, resold goods are more than the balance due, the excess is

a) considered profit for the creditor.

b) considered taxes for the state

c) divided between the debtor and creditor.

d) returned to the original debtor

Ans (d) returned to the original debtor

4. When the net proceeds from repossessed, resold goods do not cover the balance due, the creditor

a) assumes the difference as a loss.

b) might claim another possession of the debtor to sell.

c) might sue the debtor to collect the remaining balance.

d) might turn the balance over to the state for tax reduction.

Ans (c) might sue the debtor to collect the remaining balance.

5. The Uniform Commercial Code (UCC) provisions apply to security interests taken in

a) deeds.

b) mortgages.

c) personal property.

d) None of these.

Ans (c)personal property.

6. A security interest is created when

a) an agreement between the debtor and creditor gives the creditor a security interest.

b) the debtor has rights in the collateral.

c) the creditor gives value.

d) all of these

Ans (d) all of these

7. A brief written notice of the existence of a security interest in identified property that is filed with the appropriate governmental office is

a) a constructive notice.

b) a financing statement.

c) a termination statement

d) a security agreement.

Ans (b) a financing statement.

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8. Which of the following is not considered a class of goods for tangible property used as collateral?

a) equipment

b) farm products

c) inventory

d) stock and bonds

Ans (d) stock and bonds

9. The acknowledgment of the full payment that informs potential buyers and creditors that the property is no longer collateral is called

a) a constructive notice.

b) a financing statement.

c) a termination statement.

d) a security agreement.

Ans (c) a termination statement.

10. Unless the consumer agrees in writing, a creditor may not keep the collateral in satisfaction of the debt if the debt has been repaid by

a) at least 30%.

b) 50%.

c) 60% or more

d) none of these.

Ans (c)60% or more

11. What must a creditor do in order to perfect a security interest in commercial paper such as promissory notes, stock certificates, or bonds?

a) file a financing statement

b) redeem the paper

c) obtain possession upon debtor’s default

d) none of these

Ans (c)obtain possession upon debtor’s default

12. When a debtor pays the debt associated with a secured transaction, how long does the creditor have to notify the appropriate government office that the property is no longer collateral?

a) 30 days

b) 45 days

c) 15 days

d) 60 days

Ans (a)30 days

13. A person who has not been paid for labor to build a home is allowed to file a legal claim against the property under

a) an artisan’s lien.

b) a mechanic’s lien

c) a pawn.

d) a pledge.

Ans (b)a mechanic’s lien

14. A default on a loan occurs when

a) a debtor misses three straight payment

b) a debtor destroys the property.

c) a debtor misses one payment.

d) a debtor leaves the jurisdiction.

Ans (c) a debtor misses one payment.

15. Which of the following statements regarding the Truth in Lending Act is not true?

a) This law requires complete and clear disclosure of loan terms.

b) The law sets a limit as to the percentage rates that may be charged to consumers.

c) The law applies to 1^st mortgage loans and purchases of personal goods.

d) both b and c

Ans (d) both b and c

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