What is a Creditor?
Put simply, a creditor is someone to whom you owe money. The debt may be the result of a loan, an advance payment on goods or services, or something else. Creditors are very important for businesses because they provide the capital that businesses need to grow or to get them through difficult moments.
In this article, we will explain everything you need to know about creditors, from what they are to how they make money. We will also discuss the different types of creditors, how they secure their money, and what happens if you don’t repay them.
What are Creditors?
Creditors are businesses or individuals who are owed money by another business or individual. This may be due to money they have lent, products or services that have been provided with payment pending or any other number of reasons.
Creditors are also known as lenders because they are essentially lending money to the debtor with the expectation that it will be repaid at a later date. This repayment will usually include interest, which is how creditors generally make their money. The interest terms should be agreed upon by both parties before any money changes hands.
It is important to remember that creditors are not the same as investors. An investor provides capital in exchange for ownership shares in the company, whereas a creditor does not receive any ownership stake in the company. They are simply owed money by the debtor.
What are Debtors?
A debtor is the opposite of a creditor, in that they are an individual or business that owes money to another party. They are tied into an arrangement with a creditor in which they have agreed to repay the sum of money plus interest at an agreed-upon date. The repayments may be made on a monthly basis or may be paid in full at the end of a set period. Debtors are also known as borrowers because they are essentially borrowing money from the creditor with the expectation that it will be paid back.
Why Do Businesses Need Creditors?
Creditors are very important for a range of different reasons. Firstly, they provide the capital that businesses need to grow. This is especially important for small businesses that may not have the funds available to them otherwise.
Secondly, creditors can help businesses get through moments when they are not making enough money. For example, if there is a temporary downturn in the market or a problem with cash flow, a business may need to take out a loan from a creditor in order to stay afloat.
Finally, creditors can help businesses to manage their financial risk. By spreading the cost of a big project over time, businesses can reduce the amount of financial risk they are taking on.
Different Types of Creditors
There are two main types of creditors: real creditors and personal creditors.
Real creditors are businesses or institutions that lend money to businesses, such as banks and other financial institutions. They will have a range of different products aimed at businesses, such as loans and lines of credit and may also provide advice or support on financial matters.
Real creditors generally charge lower interest rates than personal creditors because they are considered to be a more secure investment. This is because real creditors often have collateral, which is an asset that can be seized if the debtor does not repay the loan. Real creditors will usually want to see your business plan and look into the company’s finances so that they feel confident you will be able to repay the loan.
Personal creditors are individuals who lend money to businesses. They may be family, friends, or private investors but there should still be a signed agreement in place which lays out exactly how much is being loaned, when the money is to be repaid and how much interest needs to be paid.
Borrowing from a personal creditor can be advantageous because you may not have to offer any collateral to secure the loan. However, it is important to remember that you are putting your personal relationships at risk if you borrow money from someone you know. Always take a professional approach to any money your business owes, even if it is to a close friend or family member rather than a bank.
What Do Creditors Provide?
Creditors provide businesses with capital in the form of loans or lines of credit. This capital can be used for a variety of different purposes, such as funding growth or covering a temporary shortfall in cash flow. The terms of the loan will vary depending on the creditor but the debt will usually need to be repaid over a set period of time with interest.
Three Types of Creditor-Debtor Arrangements
There are three main types of creditor-debtor arrangements: secured loans, unsecured loans, and lines of credit.
A secured loan is a loan in which the debtor offers collateral to the creditor. This collateral is an asset such as a house, machinery or inventory that can be seized if the debtor does not repay the loan. The advantage of a secured loan is that it is considered to be a lower-risk investment for the creditor, which means that they may be willing to offer better terms.
An unsecured loan is a loan in which the debtor does not offer any collateral to the creditor. This makes it a higher-risk investment for the creditor because they have no asset to seize if the debtor does not repay the loan. The advantage of an unsecured loan is that it is easier to obtain because there is no need to offer collateral but the interest rates may be higher due to the high risk for the creditor. However, it may still be possible to get good terms if the debtor has a good credit rating.
A line of credit is a type of unsecured loan in which the creditor agrees to lend the debtor a certain amount of money but does not specify how that money must be used. This can be useful for businesses because it gives them flexibility in how they use the funds. However, it is important to remember that the full amount of the loan must still be repaid with interest.
How Do Creditors Make Money?
Creditors make money by charging interest on the loans they lend to businesses. The interest rate will vary depending on the type of creditor, the risk involved and the terms of the loan but it is typically a percentage of the total loan amount. Creditors, particularly real creditors, may also charge fees for setting up and administering the loan.
How Do Creditors Secure Their Loans?
Creditors usually secure their loans and investments by taking a charge of the assets of the business. This means that if the business does not repay the loan, the creditor can seize and sell the assets to recoup their money. The advantage of this is that it gives the creditor a higher level of security but it can also tie up the assets of the business, which can be a disadvantage.
They may also secure a personal guarantee from the business owner. This is when the owner of the business agrees to repay the loan themselves if the business is unable to do so. The advantage of this is that it gives the creditor another source of repayment if the business fails but it can also put the personal finances of the business owner at risk.
Tips for Securing a Creditor
If you are looking to secure a creditor, there are a few things you can do to improve your chances:
- Establish a good credit rating: Creditors are more likely to lend to businesses with a good credit rating. You can build up your rating by making sure you repay any debts on time and using a business credit card for your expenses.
- Offer collateral: Offering collateral, such as property or equipment, can make you a more attractive borrower because it reduces the risk for the creditor.
- Get a personal guarantee: If you are willing to personally guarantee the loan, it may make creditors more likely to lend to you. However, this should only be done if you are confident that you will be able to repay the loan yourself if necessary.
- Have a solid business plan: This is particularly important if you are looking to secure a loan from a real creditor. They will be able to look at your plan and see if your business is likely to be able to repay the loan.
What Happens If You Don’t Repay a Creditor?
If you do not repay a creditor, they may take legal action against you to try and recover the money you owe. This could involve seizing and selling your assets or taking money from your bank account. If the creditor is unsuccessful in recovering the money, they may write off the debt. This means that they will no longer try to recover the money but it will still appear on your credit report.
However, this doesn’t mean that you should shirk your responsibilities and try to avoid repayment. A poor credit rating or a history of not repaying debts can make it difficult to get credit in the future and can affect your ability to get a mortgage, credit card and other types of loan.
What Happens to Your Debts If You Declare Bankruptcy?
If you declare bankruptcy, your debts will be written off but this doesn’t mean that you won’t have to repay them. The Official Receiver, who is appointed by the court, will sell your assets to raise money to repay your creditors. If there are no assets to sell, or the sale of the assets does not raise enough money to repay the creditors, they will write off the debt.
You will still have to repay any debts that are not written off and you will have a bankruptcy order on your credit report for six years, which will make it difficult to get credit in the future. If you have any money left over after your debts have been paid, you will be able to keep it but you will still have to declare it to the Official Receiver.
How to Record Creditors on Your Balance Sheet
Creditors should be recorded on your balance sheet as either current liabilities or non-current liabilities. Current liabilities are debts that are due to be paid within one year, while non-current liabilities are debts that are due to be paid after one year.
Creditors and invoices
If you have creditors, you will need to keep track of the invoices that they send you. This is so that you can make sure that you pay them on time and so that you can include the debts in your balance sheet.
You should keep a copy of all the invoices that you receive from your creditors in a safe place. You can either keep them electronically or in a paper filing system. If you have a lot of creditors, it may be helpful to set up a separate folder or file for each one.
You should also keep track of the payments that you make to your creditors. This will help you to keep on top of your debts and will also be useful if you need to prove that you have made a payment in the future.
As can be seen, the answer to the question “What is a creditor?” is relatively straightforward but there are a lot of things to consider when borrowing money from a creditor. You will need to ensure that you are able to repay both the loan and the interest and that you are aware of the consequences if you are unable to do so.
Creditors are an important part of business, providing the funds that businesses need to grow and expand. As long as you fulfil your obligations as a debtor, creditors can be a valuable source of finance.