What are Debtors?

Debtors are an important part of every company’s financial structure. They impact the amount of money that flows in and out of a bank account. Understanding debtors and how they work with creditors is important for both large and small businesses. Let’s understand who are debtors and how they impact the financial standing of a business

Debtor Definition in Accounting

In its most basic form, a debtor is someone who owes money to someone else. In business, a debtor means a person, company, or other entity that owes money to another because they received a service or product or borrowed money from a financial institution. They are in charge of that particular debt.

If a company takes out a bank loan, it will become a debtor to that bank. For example, if an agency agrees to borrow Rs. 1,00,000 to assist with setting up a new office, they’ll receive that money as a lump sum. They will be a debtor to the bank until it’s repaid. Also, if a customer has not yet paid a vendor for the goods and services they purchased, they will remain a debtor to that vendor until the invoice is paid. There are several personal accounts in the ledger, some of which may have debit balances. It would be excessively long to write all of the names in the trial balance. As a result, a list of names is created, together with the debit balances. This list is referred to as ‘Sundry Debtors‘.

Example: Journal entry for a credit sale of Rs. 5000.

Here, a person who obtains products or services from a business on credit or does not make the payment immediately and is liable to pay them in the future is called a ‘Sundry Debtor’.

Types of Debtors

In general, a debtor is a customer who has purchased a product or service and owes the supplier payment. Customers and suppliers are referred to as debtors or creditors for accounting purposes.

The term ‘debtor’ can apply to both a goods and services customer and someone who has borrowed money from a bank or lender. If you take out a loan to buy a house, for example, you are a debtor in the sense of a borrower, while the bank that holds your mortgage is the creditor.In general, you are considered a debtor to the lender if you borrow money. Almost every debtor has a written agreement with the creditor (supplier or lender) specifying payment terms, discounts, and so on.

Debtors Turnover Ratio

Debtors turnover ratio demonstrates how rapidly credit sales are converted to cash. This ratio assesses a company’s efficiency in handling and collecting credit from customers. The debtors turnover ratio formula is as follows:

Debtors Turnover Ratio=Net Credit SalesAverage Account Receivables

Trade debtors and bill receivables are included in the average account receivable. The higher the debtor turnover ratio, the better the company’s credit management. It indicates that a company’s collection procedures are efficient and that the company has high-quality customers who pay their debts quickly. A low ratio represents an inefficient collection, inadequate credit policies, or customers who are not financially viable or creditworthy.

Managing Debtors in Business

It’s important to successfully manage debtors if you don’t want your company to face cash flow problems as a result of non-payment of debts. If a debtor misses a payment, the debt may become a bad debt (i.e., an irrecoverable receivable), which means the company/individual to whom you extended credit will be unable to make the payment. You will be forced to write it off.

There are numerous approaches to managing a company’s debts. To begin with, one should optimize the accounts receivable procedure so that one can recover the unpaid invoices as soon as feasible. Consider providing positive incentives for on-time payments and expediting the invoice process. Furthermore, a strict credit policy might help ensure that loans are only offered to companies that can meet the repayment terms.

Understanding the Difference Between Debtors and Creditors

Individuals or corporations who have lent money to another company and are due money are creditors. It’s also important to remember that almost every company is both a creditor and a debtor, as companies frequently extend credit and pay suppliers on a delayed basis. Businesses that conduct all of their transactions in cash are the only ones likely to be debtors and creditors. Paying all transactions in cash is unheard of in medium and large businesses.

Debtors and Creditors: How Do They Work Together?

Debtors and creditors operate together in day-to-day commercial activities. They have a customer-supplier relationship, where they buy and sell goods and services on credit and pay their loan installments on time.

The amount due to a business will fluctuate in tandem with the amount it owes, altering your balance sheet’s assets and liabilities.

Customers that do not pay for goods or services in advance are debtors to a company, which acts as the creditor in this case. Similarly, if the suppliers have provided things for which they are yet to pay in full, the company is in debt to them.

While being a creditor to another company can be a valuable asset in terms of proving your company’s financial soundness, having too much debt can be a disadvantage.

The difference between the two may be consistently balanced with diligent management to ensure continuous cash flow and future-proof your organization. If one gets it wrong, the odds are stacked against the company.

How to Deal with Bad Debtors?

Overdue invoices affect every firm. The debtor list is unlikely ever to be zero, no matter how efficient a system or rigorous an approach is. Ensure to preserve a record of the debtor’s account and all communications with a client right from the start of any arrangement. This is something accounting software will take care of for you: the digital counterpart of a paper trail.

If one suspects a debtor is experiencing cash flow issues and exceeding debtor days, allow them to explain and agree to a new deadline. They have no intention of defaulting on the loan, but they are currently unable to do so. It’s now up to the lender to agree on revised terms, preferably in writing. 

Similarly, if a debtor cannot satisfy a creditor’s payment terms, be honest and professional. Informing them of the temporary difficulties and agreeing on a new payment plan can easily prevent legal issues in the future.

Conclusion

Debtors and creditors are the central points that decide how every business’ financial system operates. They have an impact on how much money flows into and out of a business account. Large and small businesses need to understand how these two terms work in conjunction with each other. Good debtor management is critical to ensure that the business has enough working capital to reinvest and grow.