Debtors refers to customers that owe money to the business, right? Or is that creditors? It can definitely get confusing.
To clear things up:
- debtors refers to customers that owe the business money
- creditors refers to suppliers that are owed money by the business.
To help you remember this, it might help to understand more about these terms.
To do this we need to go back to where the words debtors and creditors come from and take the lid off the principle behind double-entry bookkeeping!
- All of accounting is based on what is known as the ‘Dual Entity principle’, which was developed in medieval Venice. Essentially, what this principle says is that when an entrepreneur sets up a business, there are two distinct entities – the owner and the business. This makes sense if you think about how the owner can, when the time comes, sell the business – as it’s a separate entity.
- One of the first transactions to record in a new business is the owner putting some opening funding for the business into the bank – the business will need to record the money in the bank but also that the business (as a separate entity) owes the owner (as opposed to anyone else). So two entries are needed to record this one transaction – hence the term double entry which springs from the two entity principle.
- To make these entries in the books, the old-fashioned ledgers had two columns and these were called debit and credit.
- Don’t get hung up on the derivation of these words – debits and credits are just names like left and right. As it happens, credits go on the right and you can remember this because they have an r in them!
- Now, back to the question – how can I remember if debtors refers to money owed by customers or suppliers? Think about when you put money into your bank account – the bank says it is “crediting your account”. This is because from the bank’s point of view, its liability to you is increasing.So credits record increases in liabilities and hence debits, being the opposite, record increases in assets.
So just to confirm:
- debtors refers to customers owing the company
- creditors refers to suppliers who are owed by the company.
Hopefully that’s one more thing demystified – if not please get in touch!
If there’s any financial jargon you’d like me to explain, please just let us know!