Every business, however large or small, needs to keep close tabs on debtors and creditors. In simpler terms, that means understanding what your business is owed and what it owes.
The business world is based on credit. Virtually every business relies on access to goods, services and finance before paying in full for them. As a result, there are debtors and creditors. To run a business properly, it is essential to be 100% clear about the meaning of the two terms.
Debtor meaning: This is money that is owed to the business. For example, where a client or a customer has received an invoice for goods and services but this has not yet been paid.
Creditor meaning: This is money that is owed by the business. For example, where the business has been invoiced for goods or services but has not made payment.
Debtors and creditors can be thought of as two sides of the same coin. Debtors are frequently businesses and individuals who have received sales invoices, but have not yet paid them. From a bookkeeping point of view, it is essential to keep accurate records of paid and unpaid invoices.
Creditors are more diverse, and frequently include providers of raw materials and other goods, loans and services.
The relationship between creditors and debtors makes the business world tick. Without credit, it would be impossible for most startups or established businesses to prosper, and it would be just as difficult for suppliers and lenders to have tenable businesses.
As professional accountants, we advise our clients on maintaining accurate balance sheets and closely related cash flow statements. Balance sheets give a snapshot of the financial position of a business at a given moment in time. They are vital for good financial management, and are a key tool in managing the critical business discipline of maintaining a positive cash flow.
Cash flow dictates whether a business can pay salaries, rents, suppliers and other liabilities. Cash flow problems are the nail in the coffin for many small businesses. In the words of dgital accounting firm, Xero:
"Our research shows that, of the 50,000 businesses that fail each year due to cash flow issues, some 65 per cent of these blame access to funding. Quite often, the working capital they need is tied up beyond their reach with late paying customers." - Xero.com
The statistics underline the importance of managing debt and credit in their different forms. Key entries in a balance sheet are trade debtors and other debtors, as well as trade creditors and other creditors. Debtors are shown under 'Accounts receivable' as a current asset, and creditors come under 'Accounts payable' as a current liability.
Trade debtors are customers and clients for whom you have provided goods or services without yet receiving payment. Reliable customers who pay on agreed timescales do not present a problem, but late payments can create serious problems. The larger the debt, the larger the potential problem.
Balance sheets will also feature an entry for 'other debtors'. This is where businesses record payments due from organisations which are not customers - a repayment from HMRC, for example, or any loans made to other businesses.
Trade creditors are suppliers which have provided your business with goods and services for which you have not yet paid. Trading terms agreed with the supplier will dictate when payment is due. Some businesses aim to create positive cash flow by having longer credit terms than debt terms.
Other creditors listed on a balance sheet covers sums due to other entities. This could include loans from directors, especially in small businesses, put in place to help cash flow.
Keeping on top of revenue coming into and out of a business is fundamental to running a successful business. That's true for enterprises of every size, from startups to SMEs and bigger companies.
It is impossible to overstate the importance of keeping the closest possible control of revenues and outgoings in any business. Get it right and your business has a solid foundation for future prosperity. But if you don't, you risk joining the huge list of businesses which fail within a few years of starting up.
For a free consultation on how Perrys Accountants can help your business manage creditors and debtors and thrive, contact us now.