Please note that this article is intended for educational purposes only and should not be deemed to be or used as legal, employment, or health & safety advice. For guidance or advice specific to your business, consult with a qualified professional.
A creditor is a person or organisation that provides credit. The credit will have a financial value. It may not, however, be provided in cash. For example, if a company (or freelancer provides goods or services in advance of payment, they are effectively loaning money to the buyer. Often, there will be some form of specific agreement about the repayment terms.
Sometimes, however, the credit may be given informally.
Examples of creditors
Creditors come in a variety of shapes and sizes. For example, many small shopkeepers will give trusted customers informal loans to spend in their shop. This benefits the shopkeeper as much as the customer. The shopkeeper gets extra income. The customer gets to make purchases when they need them rather than when they can afford them. This is particularly useful for customers on irregular incomes.
Businesses selling higher-priced goods and services will often have formal credit schemes in place. For example, they may offer instalment plans or hire-purchase schemes. These may or may not be run at a profit. Some businesses have their own branded credit cards (store cards). Customers may also choose to get their credit from third parties such as banks.
Credit from commercial lenders may or may not be directly tied to a purchase. As a rule of thumb, loans used to buy assets tend to be more affordable than open lines of credit (e.g. credit cards). This is because they have in-built collateral and hence are less risky for the lender.
Being a creditor
In the real world, most businesses are likely to be both creditors and debtors. They will extend credit to at least some of their customers at least some of the time (even if only informally). They will also need to borrow themselves.
As a creditor, it’s important to exercise robust credit control. In simple terms, you should only loan money to people or organisations you can trust to make the repayments. At a minimum, it’s advisable to check their credit score before agreeing to offer them any meaningful amount of credit. It’s preferable to have an established transaction history with them.
Sometimes, however, this is not practical.
Furthermore, before you loan anything to anyone, you need to have a process in place for handling debtors who make late payments and/or get into arrears. The main reason for setting this out in advance is that it makes sure that you stay on the right side of the law when handling your debtors. Another reason is that it makes sure that you treat all debtors consistently and fairly.
Pursuing debt arrears can be one of the most challenging jobs in business. The more effective you are at it, however, the less you will have to deal with bad debts and bad debt write-offs.
Being a debtor
A lot of companies will need to borrow money for one reason or another. Probably the most common reasons are to manage cash flow and to finance growth. Younger companies may also choose to borrow money even if they don’t actually need to. This allows them to build up a credit history that they may choose (or need) to leverage later.
It’s important to manage your debts wisely or else they can end up consuming too high a proportion of your income. There are generally two keys to managing debts effectively. The first is to budget and forecast as accurately as you can.
This should highlight both any potential cash-flow issues and any reasons to borrow to finance growth.
Once you know how much money you need and for how long, you can look at the most appropriate way of borrowing it. In some cases, this may involve using a combination of products. For example, you might use a business credit card to help manage your cash flow and a loan to buy long-term assets.