Understanding Trade Creditors: Their Role in Business Finance and Risk Mitigation
What is a trade creditor?
A trade creditor is a business or entity that owes money to another. When a trading partner extends a line of credit to your company so that you can purchase goods without paying for them yet, they become one of your trade creditors. They may also be referred to as creditors or accounts payables. On your trading partner's books, you will be referred to as a trade debtor, or debtor – someone that owes them debt. When you have paid the invoice, you are no longer their trade debtor. If you accrue trade creditors, these are invoices you must pay. Until then, they are liabilities.
However, if you accrue trade debtors – as in, you are someone else's creditor – and should there be an issue with your trading partner, this can cause future cash flow problems. It is this scenario that we're mostly going to talk about as this article continues; while you never want to be left in a situation where a debtor won't/can't pay, there are many ways you can prepare for or circumvent the problem.
How does a trade creditor differ to other creditors?
If you research 'creditor' online, you may come across three other common terms that are not to be confused with trade creditors:
1. Sundry creditors - In many accounting platforms, sundry creditors and trade creditors are lumped together. However, there is a difference.
- Sundry creditors are suppliers who provide infrequent, small-purchase goods to your company on credit. In your books, you would not give them an individual ledger, but group multiple sundry creditors together into a category, for example "Infrequent Suppliers".
- Compare this with trade creditors, such as those providing your business with raw materials. They are assigned an individual ledger account, marked as liabilities as above, and dealt with separately.
2. Secured and unsecured creditors - In business insolvency, two additional terms are used: secured and unsecured creditors. These impact the running of your business if you are dealing with a company that, after negotiating trade credit, files for bankruptcy. In this case, you are classified as a secured or unsecured creditor of theirs.
- Secured: Your credit is tied to a security or asset held by the debtor. It is agreed in your contract that should they fail to pay their debts, you have the right to seize the asset and sell it to recoup your losses.
- Unsecured: The opposite of the above. You do not have a right to seize the asset should your debtor fail to pay, meaning you must try and make back the money you've lost through other means, for example through a debt collection service.
What happens if my debtors can't pay?
Writing off unmanageable debt may allow you to claim a tax deduction at the end of the fiscal year. In this scenario, you are someone else's trade creditor, and it appears that they cannot pay the credit. If this occurs, a few things may happen. First, you may wish to turn the debt into unmanageable debt in your accounts receivable. This can allow you to remove the outstanding balance from your books, apply for a tax deduction at the end of the fiscal year, and/or potentially claim back GST credits. If your debtor has gone into insolvency, you cannot keep demanding repayment of the debt. However, you can negotiate with their trustee for repayment after the bankruptcy ends and liabilities are being extinguished.
How to protect against bad debt
The best defense against bad debts as a trade creditor is to prepare for them in advance. This is where credit control strategies come into play, or in other words, strategies used to help you get paid quicker (or avoid unmanageable debt in the first place). Most notably, one of the key strategies you should consider is trade credit insurance (TCI).
What is trade credit insurance?
TCI is highly valuable when accruing trade creditors or debtors. With a TCI policy from the likes of Coface, you are getting a package of two potentially vital services:
- Customised Credit Opinions (CCO): When you are planning trade with overseas partners, Coface conducts thorough research on your behalf into their financial background and current business strengths. We can then alert you of any red or amber flags, to help you make an informed decision about whether to trade in credit, cash, or walk away.
- Indemnification of unpaid debts: Should worst come to worst, our international debt collection services can help you recover your lost finances. We operate in approximately 200 countries and have been around for over 75 years, giving us access to an unrivalled network of contacts and partners across the globe. This helps us secure repayments in countries you may struggle to deal with on your own.
The level of confidence you can have when working with Coface may help you with your creditors. If your invoices are paid on time, this frees up the cash you require to pay your debts and maintain strong relationships with overseas and domestic partners. To find out more about how Coface might be able to help your specific business, even if you're a small or medium-sized enterprise, contact us today.