When analysing UK company financial statements and filing them with Companies House, understanding the difference between debtors and creditors is essential.
Debtors and creditors, alongside their associated payment terms, are key to assessing a company’s financial health, liquidity, and cash flow management. This understanding is vital for managing day-to-day business operations and long-term planning.
Whether you're an investor, accountant, or a business owner, knowing how to interpret debtors and creditors and the role they play on the balance sheet and in day to day business operations will give you a clearer view of a company’s financial standing.
It doesn’t matter if your business is small. Any business will benefit from this understanding, and it could be argued that it's even more important for smaller businesses to keep on top of this analysis. Small businesses have a high failure rate, and might struggle to get funding easily. They often rely heavily on receiving receipts in a timely manner to be able to keep up with the short demands on their cash. This is especially true in recent times with rising prices and increased interest costs.
In this article, we’ll explore what debtors and creditors are. How to categorise them on the balance sheet under UK accounting standards. How various payment terms, like interest rates on loans or credit terms, affect their classification.
We’ll also look at the difference between secured and unsecured creditors, and how factors like loan creditors and unpaid invoices play a role in a company’s balance sheet.
What are debtors?
Simply put, debtors are people or businesses that owe money to the company, usually for goods or services they haven’t paid for yet.
Debtors represent assets on the balance sheet, as they reflect future inflows of cash to the company.
In the UK, companies often allow credit terms, meaning customers can pay after receiving goods or services. Financial Institutions such as banks can also be debtors if they owe unpaid interest or if the company has loaned them money.
Types of debtors
- Trade Debtors: These are customers who owe money for goods or services purchased on credit. For example, if a retailer sells goods to another company but allows them 30 days to pay, that company becomes a trade debtor. Small businesses often have a high proportion of trade debtors, which can be important for managing their cash flow.
- Other Debtors: This includes anything else owed to the company that doesn’t come from sales. This can range from loans made to employees and overpaid or prepaid invoices from suppliers. Other outstanding receivables could also be interest receivable, and amounts recoverable from tax authorities.
Debtors on the balance sheet
The balance sheet splits debtors into:
Current assets (receivables expected within one year)
Non-current assets (receivables expected after more than one year).
Example of debtors: Fox Pharma Limited
Let’s take the example of Fox Pharma Limited, a seller of aesthetic supplies. As of 31 July 2023, under current assets, debtors are listed at £9,487,070 for 2023, compared to £3,961,310 in 2022. This increase shows that more money is owed to the company by customers and related or other entities. This makes up a significant part of the company's short-term assets.
To understand the breakdown of those Debtors, you can take a look at the notes to the financial statements (Note 5):
- Trade Debtors are £137,762 in 2023, up from £37,581 in 2022. This reflects amounts owed by customers for goods or services that Fox Pharma has provided on credit.
- The most significant line item in debtors is Amounts Owed by Group Undertakings, which total £9,282,108 in 2023, compared to £3,891,581 in 2022. This refers to money owed to Fox Pharma by other companies within the same group.
- Other Debtors, which include various amounts such as tax refunds or loans, amount to £67,200 in 2023, up from £32,148 in 2022.
In total, Fox Pharma expects to receive £9,487,070 within the next year, making debtors a major part of the company’s assets. This amount is important for the company’s short-term financial position, as it shows what Fox Pharma expects to collect in the short term.
This information helps with financial and cash flow planning. It allows the company to see if it has enough short term, and hence more liquid assets, to cover any short term liabilities, or creditors, and ongoing business operations.
The company will also need to assess whether these debtors and other short term assets are actually all still collectible. Some debt may need to be impaired or written off. As Fox Pharma’s debtors have increased significantly since 2022, an assessment should be undertaken to ensure they are correctly reflecting the company’s financial position as at the balance sheet date.
What are creditors?
In contrast, creditors are individuals or entities to whom the company owes money to. This can range from suppliers to tax authorities. Creditors are classified based on their payment timelines.
Creditors are listed as liabilities on the balance sheet because they represent future economic obligations the company must fulfil. They can include loan creditors or unsecured creditors with specific loan terms.
Types of creditors
- Trade Creditors: Suppliers who have provided goods or services on credit, expecting payment within a set period. For example, a manufacturer that buys raw materials on credit will owe money to its suppliers, and this will be recorded as trade creditors.
- Other Creditors: These can include tax liabilities, salaries payable, or other unpaid invoices.
Creditors on the balance sheet
The balance sheet splits creditors into:
- Current liabilities: amounts payable within one year
- Non-current liabilities: amounts payable after more than one year
Example of creditors: Advantis Credit Limited
The 2023 balance sheet of Advantis Credit Limited shows: creditors: amounts falling due within one year amounted to £15,882,828, and creditors: amounts falling due after more than one year were £101,940.
This classification helps distinguish between:
- Short-term obligations, such as invoices from suppliers.
- Long-term liabilities, such as loans or lease obligations.
Long term loans and lease obligations will have some payments due within the next 12 month period (short term obligations). It's important to note that this short term portion of the longer term liabilities should be split out, and included in short term creditors.
Amounts falling due within one year vs. after one year
The classification of debtors and creditors into amounts falling due within or after one year is very important. They form a significant indicator of a company’s liquidity. These classifications determine whether the company can meet its short-term financial obligations and how well it’s positioned to manage long-term debt.
Amounts falling due within one year
- Debtors due within one year: Amounts receivable with the next year are classified as current assets. They represent expected cash inflows from the outstanding debtors. The company's ability to collect this money in a timely manner affects its liquidity and operational efficiency.
- Creditors due within one year: Amounts payable within the next year are classified as current liabilities. They represent expected cash outflows from the outstanding creditors. These can include amounts owed to suppliers, loan creditors, and unsecured creditors, as well as any unpaid taxes or salaries. Effectively managing these liabilities is important for maintaining good relationships with suppliers and financial institutions.
Example of creditors amounts due within one year: Lily Phillips Limited
The balance sheet of Lily Phillips Limited shows:
Creditors: amounts falling due within one year amount to £60,995 for 2023, compared to £99,857 for 2022. These represent short-term obligations that must be settled in the next 12 months, such as payments to suppliers or taxes.
Amounts falling due after one year
- Debtors: Classified as non-current assets, they are amounts the company expects to receive after more than 12 months. They often include long-term loans or deferred receivables.
- Creditors: Classified as non-current liabilities, they are amounts the company expects to pay after more than 12 months. Examples include long-term loans and lease obligations.
Example: Go Teach Maths Ltd
The balance sheet for Go Teach Maths Ltd separates creditors amounts falling due within one year (shown as £18,337 for 2024) from other liabilities such as accruals and deferred income of £98,750. These deferred liabilities might be settled after one year, making them part of the company’s long-term financial commitments.
The importance of differentiating debtors and creditors
Understanding the difference between debtors and creditors is critical for businesses. Both impact the company’s liquidity, creditworthiness, and overall financial health.
For example, high levels of debtors can show strong sales but could also suggest issues with cash collection, especially for small businesses.
A high level of creditors, particularly if they include unsecured creditors or loan creditors, can signal the company is heavily reliant on external financing. This reliance can pose risks in terms of financial stability.
How financial institutions and banks view debtors and creditors
Financial institutions, including banks, closely monitor the balance between debtors and creditors (Net Assets) in a company’s financial statements. They use this information to assess a company’s ability to repay loans, or to extend additional lines of credit.
A company with high debtor balances might be seen as a risk if those debts are not being collected on time. Especially if these debts relate to unpaid invoices or extended credit terms.
Similarly, a company with high creditor balances, especially from loan creditors, might face scrutiny if the loan terms are not favourable, or if the company struggles to meet its short-term financial obligations.
Conclusion
The balance between debtors and creditors on a company's financial statement gives important insight into its liquidity, solvency, and financial stability.
Understanding how debtors and creditors affect a company's finances is crucial for both the management and outside parties like banks. This includes reviewing payment terms, handling unpaid invoices, and managing loans. For small businesses, keeping a good balance between debtors and creditors can make the difference between success and failure.
