What is a creditor in business?
A creditor is an individual business to whom money is owed. This is usually because they loaned you money, a product or a service.
Many businesses can also find themselves becoming creditors, simply through being owed money. In most cases, this is via mutually accepted payment terms.
For example, a window fitting company might approach a supplier to purchase £10,000 worth of glass panes on credit. The supplier agrees, becoming a creditor and giving the window fitting company 30 days to pay.
Creditors vs debtors: what’s the difference?
The terms creditor and debtor represent different roles in a financial transaction, though their distinction is simple. Where a creditor refers to someone to whom money is owed, a debtor refers to an individual, institution, or entity that owes the money.
A prospective debtor may approach a creditor and agree to payment terms of 30 days. Once the creditor provides the product or service, the debtor then has 30 days to repay. Staying with the earlier example, our window fitting company becomes the debtor upon entering the credit agreement with the supplier, while the supplier is the creditor.
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Types of creditors
There are various types of creditors, each with different characteristics and roles. Below are three common types of creditors:
Trade creditors
A trade creditor is a supplier or vendor from whom a business purchases goods or services on credit. In these arrangements, the supplier or vendor becomes a creditor.
Real creditors
Real creditors are those banks and other financial institutions from which businesses may borrow funds to finance their operations or capital expenditures. In entering the agreement, the banks or financial institutions become creditors.
Personal creditors
An individual or entity to whom you owe money personally could be considered to be a personal creditor. For example, you may have used personal creditors in the early sole trader stage of your business, when a friend or relative loaned you money to get started.
Types of credit
There are also different types of credit, each with different payment terms and mutually agreed characteristics:
- Open account credit: Open credit is typically activated by the company providing goods and services and then issuing an invoice for payment.
- Instalment credit: Payment to the creditor is made in instalments, based on an agreed schedule and rate of interest, if applicable.
- Revolving credit lines: The creditor provides a credit limit to customers. Once the balance is paid off in full, the facility remains open for future credit use.
- Consignment credit: Where a supplier provides goods to a retailer, who only pays for sold items, minimising upfront costs and inventory risks.
Everything you need to know about creditors
The better your past relationships with creditors, the more likely you are to enter into new and potentially more substantial credit agreements in the future. Below is everything you need to know about creditors and credit agreements:
Establishing payment terms
Understanding and accepting your supplier's payment deadline is key to preserving your business partnerships and managing spending. Usual payment terms are 30 days, but can extend up to 90 or 120 days, or suppliers may demand immediate payment upon receiving goods.
Creditors who trust their debtors may offer more favourable terms, such as longer to pay and lower or zero interest rates.
Managing your payables
A business should make sure it has a healthy system for recording and paying its creditors. At the very least, this would include a list of all creditors, their contact information, payment information and payment terms. You should always aim to pay your creditors promptly.
Cash flow management
Perform some basic due diligence before entering into a credit agreement; make sure to diarise when future payments would be expected and the amount owed. It may be possible to arrange for your payment terms to fall after your business receives a large, regular payment. Creditors usually accept smaller payments from your business throughout the month, as long as the full balance is cleared by the billing period's end.
Communicating with creditors
Keeping a dialogue going with your creditors is important for several reasons. A positive, longer-term relationship may result in more favourable credit terms. More frequent conversations with your creditors can also help keep your business in the loop with special offers and bespoke products or services.
Managing late payments
Penalties for late payments could include additional interest payments. The Late Payment of Commercial Debts (Interest) Act 1998 provides a legal right for suppliers to charge interest on overdue payments from their customers. The interest rate is set at 8% above the current Bank of England base rate [1], but may also be determined by the contract itself. There are also fixed sums attached to late payments, depending on the amount owed, to cover debt recovery costs.
In navigating the challenges of late payments, prioritise proacting invoicing and establish a clear line of communication with your creditor³.
1. The maximum payment period on purchases is 54 calendar days and is obtained only if you spend on the first day of the new statement period and repay the balance in full on the due date. If you'd prefer a Card with no annual fee, rewards or other features, an alternative option is available – the Business Basic Card.
2. Membership Rewards points are earned on every full £1 spent and charged, per transaction. Terms and conditions apply.
3. The information provided in this article is for informational purposes only and does not constitute financial advice. Always consult a qualified professional before making financial decisions. We are not liable for any actions taken based on this information.
Sources
[1] UK Government Legislation, Late Payment of Commercial Debts (Interest) Act, 1998
