In business, the terms creditor and debtor refer to the parties involved with borrowed funds such as bank loans, credit extended, notes payable, or bond sales.

The critical requirement of the creditor-debtor relationship in business is a debt agreement (or contract) stating explicitly the legally binding rights, responsibilities, and obligations of both parties. Business debt agreements typically enumerate also the legal remedies available should either party fail to meet its responsibilities.

 

 

Explaining Creditor and Debtor in Context

Sections below further describe the creditor-debtor relationship in context with related terms including the following, focusing on three themes:

• First, legal rights and responsibilities of both parties in a debtor-creditor relationship.
• Second, reasons that almost all businesses take on debt, simultaneously playing the role of debtor to their creditors, and creditor to their own customers.
• Third, remedies available to creditors when debtors do not pay.

• What is internal rate of return?
  • Define Internal Rate of Return IRR.
• How do textbooks define the internal rate of return IRR? Example illustration.
• First IRR Interpretation: IRR as a measure of risk.
• Finding IRR: Can you calculate IRR?
• IRR Graphical Solution.
• IRR Spreadsheet Solution.
• Re-defining IRR: Why is it called internal rate of return?
• Second IRR interpretation: Financing costs and reinvestment gains.
• Is modified internal rate of return (MIRR) a better metric than IRR?
• How does IRR How does Internal rate of return compare to NPV, ROI, and other financial metrics?
  • IRR vs. MIRR, NPV, ROI, and Payback Period.
  • IRR is the same as Yield to maturity (YTM) for bond investing.
• Is IRR appropriate for lease vs. buy analysis? What are other problem IRR results?
  • Lease vs. Buy vs. IRR.
  • Negative, multiple, and impossible IRRs.
• Four commandments for using IRR.

Related Topics

• NPV, ROI, Payback and IRR cash flow metrics. See Financial Metrics.
  

The First Interpretation of IRR Meaning: IRR As a Measure of Risk

Consider two investment proposals competing for funding: Case Alpha and Case Beta. Table 1 shows the net cash flow streams forecasts for Alpha and Beta investments.

Different IRRs for Front Loaded and Back Loaded Cash Flow Streams

Both cases call for an initial cash outlay of $220. However, Case Alpha brings a net gain of $200 over seven years while case Beta brings a net profit of $240 over the same seven years. For that reason, it is tempting to designate Alpha as the better business decision, because Alpha ultimately returns greater net CF. Before deciding, however, experienced analysts will also want to compare these CF streams on the basis of IRR and possibly other metrics, as well.

Before finding IRRs and other metrics, note especially from a graphical display (Figure 2) how the two cash flow streams differ.

IRR is the Discount Rate That Brings NPV to Zero

The Table 2 and Figure 3 show the result of applying IRR Definition 1, that is, finding IRR as the discount rate that brings an NPV of 0. Note that this example shows only one of the above cash flow streams from Table 1, Case Alpha.

In Figure 3 below,

• Dark blue bars are future value net cash flows for Case Alpha.
• Gray bars are present values of the same cash flows at IRR discount rate of 30.6%.

You should be able to see or imagine that the heights of the seven positive (upward pointing) gray bars starting with Yr 1 add up precisely to the length of the one negative (downward pointing) light gray bar at "Now." As a result, the IRR definition is satisfied because the total of positive PVs equals the sum of negative PVs.

The IRR outcomes and problems above suggest four rules, or "commandments" for IRR usage:

1. IRR is not appropriate when the net cash flow stream differs substantially from the profile with early-arriving net cash outflows and later net cash inflows.
2. Do not use IRR to compare competing cash flow streams whose profiles differ substantially from each other.
3. The analyst should not over-interpret IRR magnitude and return rates when IRR differs substantially from the real cost of capital and real earnings rates for returns.
4. Do not expect to find an IRR when the net cash flow stream is entirely positive or entirely negative because there is no IRR for such situations.