Welcome to the Premier Website for Professional Business Analysis

Who Are Creditors and Debtors?

In modern business, companies often serve as creditors to their customers and debtors at their bank at the same time.

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.


Define Creditor and Debtor

A creditor is a party who lends money or extends credit to another party, the debtor. Fir the life of the debt, creditor and debtor have a legal relationship with each other.

Creditors and debtors may be individuals, or they may be legal entities such as public or private corporations, registered companies of another kind, a chartered or registered organization, or a government. All of these can legally borrow and lend funds


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.



Why Do Companies Borrow and Take on Debt?
Borrowing & Lending, the Heart of Modern Business

Anyone can understand why an unprofitable, struggling company might create debt (borrow) to survive while trying to rebuild the business. However, people not in "business" sometimes ask why a profitable, well-funded firm would borrow or otherwise take on debt. Many are no doubt thinking of Shakespeare's best-known quote on borrowing and lending. In Hamlet, the character Polonius advises his son:

"Neither a borrower nor a lender be,
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry."

The wisdom of Polonius notwithstanding, borrowing and lending sit, irremovably, at the heart of business operations today. Companies that sell goods and services are creditors and debtors at the same time. They are creditors to customers who purchase goods but before they actually pay for the products (the company's accounts receivable) while at the same time they can be debtors to their bondholders and banks.

Business borrowing, moreover, is a normal practice in modern finance. Boards of Directors sometimes expect their financial officers to borrow funds to purchase assets that produce returns for their owners that exceed the cost of borrowing.

What Happens When the Debtor Does Not Pay?
Accounting Solutions and Legal Solutions

Usually, when customers fail to pay on time or otherwise fail to meet payment agreements, the creditor bank or merchant still tries for a period to persuade the customer to pay. Creditors specify in advance the number of days they can let these attempts continue, for example, 30, 60 or 120 days. If the customer does pay during that time, the creditor may or may not add a "late charge."

If, however, the customer still does not pay during that time, the creditor may choose to write off the amount due as a bad debt. The write-off is an accounting practice that that does the following:

  • A "write-off" reduces the creditor's Balance sheet Accounts Receivable. Accounts receivable is an Assets account.
  • The same write-off also appears on the creditor's Income statement as an expense. Bad debt expense is a noncash Expense account. The Bad debt expense lowers profits, of course, but it does not decrease reported Revenues from sales. These revenues have been earned and legitimately claimed, even if the customer fails to follow through with cash payment.

Writing off debt by the creditor is an accounting practice, but it does not remove the debtor's obligation to pay. The creditor may still attempt to collect payment by engaging a collection agency or pursuing other legal means.

The Creditor's Last Resorts

When the remaining debt is sufficiently large, creditors may try a more costly recovery attempt.

  • The creditor may sue the debtor with a lawsuit that will, if successful, bring a court order for the debtor to pay. Note that the debtor is already legally bound to pay the debt, but a court order adds to the creditor's ability to enforce payment.
  • In cases where the debtor has a secured loan (or asset-based loan) when the debtor does not pay, the creditor may take ownership of the collateral assets.

    When the collateral is property, such as an automobile, the creditor is said to repossess the collateral. And, when real estate properties serve as collateral, the creditor forecloses the loan.

In both cases (repossession and foreclosure), the actions are possible because the lender—not the borrower—legally owns the collateral until the debtor fully pays off the loan. The purchaser takes possession of the auto title, or real estate title deed, only after paying off the debt.

Non Payment is Not a Criminal Offense.

Non-payment of a legal debt is a civil offense, not a criminal offense, almost everywhere. Most people know that legal jurisdictions everywhere abolished debtors prisons and jail terms for non-payment practically everywhere, many years ago.

While non-payment is not, itself, a criminal offense, the manner in which buyers or borrowers acquire debt can be a different matter. Criminal prosecution and imprisonment are a real possibility if obtaining the loan involves a criminal offense of some kind.

  • Creditors can, in some cases, prosecute a debtor who willfully abstains from making a court-ordered payment. This kind of order follows, for instance, when a parent fails to pay court-ordered child support. The critical issues in such cases are the debtor's will and the debtor's actual ability to pay.
  • A debtor can be criminally liable for debt acquired through fraud. Fraud is involved when debtors obtain loans by knowingly overstating their ability to repay or overestimate the value of their asset base.