Think of your business like a bathtub. Money flows in from your customers (debtors) and flows out to your suppliers and lenders (creditors). To keep the water level even, you need to manage both taps carefully, making sure cash flows in as smoothly as it flows out.
In plain English, debtors are those that owe you money, appearing as assets on your balance sheet, while creditors are those you owe, showing as liabilities. Understanding how these financial transactions impact your business is essential to good financial health.
In this guide, our expert accountants break down the jargon and explore how both debtors and creditors impact your cash flow and your day-to-day decision-making.
What are Debtors?
Debtors are simply people or businesses who owe you money. When you sell goods or services on credit (allowing later payment), those customers become your debtors until they pay. You may also have loaned money to directors or staff members who are obligated to settle the debt in the future.
Your debtors might include:
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People who you have supplied products to but haven't yet paid (trade debtors)
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Clients with ongoing payment plans
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Anyone who's borrowed money from your business
When you are owed money by trade debtors or other people who have borrowed money from your business, this appears as an asset on your balance sheet. Assets represent funds that will (hopefully) come into your business soon.
How Debtors Impact Your Business
The way you manage debtors directly affects your business health. Timely payments from those who owe you money ensure you can pay your own bills, invest in growth, and avoid borrowing unnecessarily.
When buyers pay promptly, you maintain positive cash flow. However, late payment or non-payment can quickly create cash flow issues that ripple throughout your operations.
Warning Signs of Debtor Problems
Watch out for these red flags that might indicate trouble with your debtors:
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An increase in average payment times - that is, if buyers are taking longer to pay than before
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A growing proportion of overdue invoices - when more than 20% of invoices are overdue, it's a cause for concern
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Repeated requests for extended payment terms from the same customers
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Having to chase the same clients repeatedly for payment
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Cash flow regularly falling short
Spotting these warning signs early can help you take action before small issues become major problems.
What are Creditors?
Creditors are individuals or businesses to whom you owe money.
These might be:
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Suppliers who've provided goods or services on credit (trade creditors)
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Banks and financial institutions that you've borrowed money from (loan creditors), which could include mortgages, business loans or credit card debt
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Landlords you pay rent to
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Tax authorities like HMRC
Your business's creditors appear as liabilities on your balance sheet. Liabilities represent money that will flow out of your business.
How Creditors Impact Your Business
Your relationship with trade creditors directly affects your operational capacity and financial stability. For example, if you maintain good supplier relationships, you can negotiate better credit terms to help smooth out cash flow bumps. Loan creditors such as banks and other financial institutions provide capital for growth, but come with interest costs and financial obligations.
Balancing these relationships is crucial. If you pay too slowly, suppliers might restrict your credit, and if you borrow too much, loan repayments could strangle your funds flow.
Warning Signs of Creditor Problems
Be alert to these indicators that your creditor management needs attention:
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Regularly paying bills late or missing payment deadlines
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Receiving payment reminders or warning letters from suppliers
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Suppliers reducing limits or requiring advance payment
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Constantly reaching the limit on business cards or overdrafts
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Prioritising which bills to pay because you can't cover them all
These signs suggest your business might be facing cash flow issues that need addressing promptly.
Common Mistakes in Managing A Business's Creditors and Debtors
Even experienced business owners can fall into these common traps when managing creditors and debtors:
For debtors:
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Not setting clear payment terms at the outset
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Failing to check new customers before extending credit
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Inconsistent invoicing processes that delay payment
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Being too timid about chasing payment for fear of damaging relationships
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Not tracking ageing debts until they become serious problems
For creditors:
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Missing opportunities to negotiate better terms with suppliers
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Settling bills too early when you could be preserving cash
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Not exploring alternative financing options for large purchases
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Failing to build relationships that might provide flexibility when needed
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Ignoring early warning signs of cash flow problems
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Paying too much interest by not checking the loan market regularly
Avoiding these pitfalls can significantly improve your cash position and business stability.
Questions to Ask About Your Debtor and Creditor Management
Take a moment to assess your current situation with these key questions:
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Do you know exactly how much your business's debtors are right now?
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What's your average collection period (how long it takes buyers to settle up)?
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Do you have a system for tracking owed money and overdue payments?
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Have you established clear payment terms that clients understand?
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Do you have any clients who consistently pay late?
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Do you know the payment terms for each of your suppliers?
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Are you taking advantage of any early payment discounts from suppliers?
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Do you have a forecast that accounts for both incoming and outgoing payments?
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Is your business reliant on a single large customer or supplier?
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Do you have emergency funds or facilities available if there's a cash flow crunch?
Your answers will highlight areas where you could strengthen your financial management.
Effective Ways to Manage Debtors and Creditors
Striking the right balance between owed money coming in and funds going out keeps your business healthy. Here are practical approaches for both creditors and debtors.
Managing debtors:
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Create transparent payment terms and communicate them up front
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Send invoices promptly to encourage timely payments
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Consider offering small discounts for early payment to reduce debtors
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If you are owed money, follow up quickly on overdue accounts
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Take legal action if necessary to ensure debt is settled
Managing creditors:
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Negotiate the best possible payment terms with suppliers
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Schedule payments to align with your cash flow pattern
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Build strong relationships with key suppliers to get longer credit terms
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Keep open communication if you anticipate payment difficulties with your creditors
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Consider alternative financing options for major purchases
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If you find yourself unable to settle debt, you may be able to arrange a company individual voluntary arrangement, which can extend credit terms.
With thoughtful management of both debtors and creditors, you can maintain positive cash flow even during challenging times.
We Can Help You Take Control
Managing the balance between your debtors (money owed to you) and your creditors (money you owe others) doesn't need to be overwhelming. With the right systems and support, you can transform this aspect of your business from a source of stress to a strategic advantage.
At Unicorn Accountants, we help small businesses like yours optimise cash flow and build stronger financial foundations. Ask about our comprehensive accounting services packages. Our team can help you implement practical systems for tracking payments and help you manage both debtors and creditors effectively.
Ready to take control of your cash flow? Connect with us today, and let's turn your financial challenges into opportunities for growth.
Frequently asked questions about debtors and creditors
How can I encourage customers to settle invoices faster without damaging relationships?
Set clear expectations from the start, make paying easy with multiple payment options, send friendly reminders before due dates, and consider early payment incentives rather than late penalties.
Is it always bad to pay creditors late?
Yes. Late payments to your trade creditors can damage your business reputation, incur fees, and harm supplier relationships. Pay suppliers on time whenever possible. If you're struggling, maintaining communication is vital. Generally speaking, it's always better to proactively contact your supplier and arrange alternative terms. If you pay loan creditors late, this can affect your score and ability to get credit in the future.
Should I use financial checks for all new clients?
For significant orders or ongoing relationships, yes. For small one-off purchases, the administrative cost might outweigh the benefit.
How much working capital should I keep to manage cash flow gaps?
Most financial experts suggest having enough to cover at least 3-6 months of operating expenses, but this varies by industry and business model.
What's the first step to improving my creditors and debtors management?
Start by getting complete visibility of your debtors and creditors. Understand the amounts and the due dates. You can't manage what you don't measure.
What is the Consumer Credit Act?
The Consumer Credit Act is UK legislation that regulates credit and lending, protecting consumers by requiring clear information disclosure, establishing fair practices, and providing specific rights to debtors in consumer credit agreements.