WallStreetMojo

WallStreetMojo

WallStreetMojo

MENUMENU
  • Free Tutorials
  • Certification Courses
  • 250+ Courses All In One Bundle
  • Login
Home » Accounting Tutorials » Liabilities Tutorials » Debtor

Debtor

Debtor Meaning

Debtor is a person or any other form of party in a transaction which owes money to the other party. The receiver is called as creditor while the giver is known as the debtor and the payment terms vary for each transaction based on the terms and conditions discussed between the parties.

In case of a mortgage, the Debtor pays interest in exchange for a loan taken from the lender in addition to the principal borrowed.

Debtor

How to Calculate Oustanding Loan of Debtor?

Case 1

Return of simply borrowed money without interest:

Borrowed Capital = Capital to be Returned

Case 2

Return of simply borrowed money with simple interest

Amount to be Returned (A) = Principal (P) * Rate of interest (R) *Time (T) /100

Case 3

Return of simply borrowed money with compound interest

Amount to be Returned (A) = Principal (P)* [1 + Rate of interest (R)]^(Time (T)   

Debtors, in most cases, are required to pay as per compounding rate of interest.

Examples of Debtor

You can download this Debtor Excel Template here – Debtor Excel Template

Example #1

Mr. A wishes to buy a car worth $100,000. He can invest $30,000 from his available savings. However, he is falling short of $70,000. He approaches a financial consultant who advises him to opt for a personal loan.

Mr. A visits ABC Bank, which offers him a loan of $70,000 for a term of 5 years to be returned with 10% interest annually. Upon signing up for the loan, Mr. A is known as a “debtor” and bank, which is the other party is called the “creditor.” Once Mr. A is paid out with the loan amount, he approaches the car dealer, pays him the amount of $100,000, and gets the ownership of that car.

Popular Course in this category
Sale
All in One Financial Analyst Bundle (250+ Courses, 40+ Projects)
4.9 (1,067 ratings)
250+ Courses | 40+ Projects | 1000+ Hours | Full Lifetime Access | Certificate of Completion
View Course

However, as part of the amount is his indebtedness to the bank, he needs to repay it to them based on their credit terms.

As the interest calculation is not mentioned as a compounded basis, it is understood to be simple interest.

  • Principal (P): $70,000
  • Term (T): 5 years
  • Interest rate (R): 10% annually

Therefore, calculation of the amount to be paid at the end of 5 years using below formula is as follows,

Amount to be paid at the end of 5 years (A) = [(P X R X T)] + Principal (P)

Debtor Example 1

  • (A) = 70,000 + [(70,000 X 10% X 5)]
  • = $105,000

Based on the calculation, the interest portion is $35,000, and the Principal is $70,000.

Example #2

Anna gets into a debt of $20,000 for a period of 2 years at an interest rate of 2% compounded annually. Anna is a debtor in this case. Calculate the amount to be paid at the end of 2 years and total interest paid on this debt.

(Assume Anna pays the installments on an annual basis).

Solution

  • Principal (P): $20,000
  • Interest Rate (R): 2% annually
  • Time (T): 2 years

Therefore, calculation of amount to be paid at end of 2 years using below formula is as follows,

Amount (A) = [P (1 + R) ^ T ]

Debtor Example 1.1

  •  (A) = [20,000 ((1 + 2%)^2)]
  • = $20,808

Total Interest Paid for this Debt

Example 1.2

Total interest paid for this debt = $20,808 – $20,000 = $808.

Advantages

  • The amount borrowed can be raised at once. The loan amount (or debt) can be received as once, which is repaid later in installments. In case of urgent requirements, when the Debtor is short of required capital, debt can be raised to suffice immediately.
  • Raising a loan is a way to leverage money in markets. Idle money lying with creditors can be put to use to create more money by lending out to debtors. The debt can be based upon agreed terms and conditions between the parties.

Disadvantages

  • It is a form of liability. Due to the time value of money, every penny lent costs more in the future than today. Hence there is an interest attached to indebtedness. A debtor always has an element of repayment attached to its finances. Even though the payment may be in smaller installments for future dates, what he pays is more than that availed from the creditor.
  • Creditor always keeps their terms and conditions at the time of lending, which has to be followed by the Debtor in order to avail the loan.
  • Too much indebtedness reflects negatively on the balance sheet.
  • The creditor faces a default risk. The Debtor may default in future payments on the loan. Hence there is a risk involved in such a deal. In most cases, creditors are required to hedge their risk by entering into an offsetting position.

Limitations

  • A debtor may or may not be aware of the benefits he can derive from interest rates. Interest rates are very volatile in markets, and once they start fluctuating, the actual returns/payments on security may change largely. However, it is difficult to predict the movement in the future. Hence, they have to go into an agreement for debt as per their view on the market, which may or may not be correct.
  • A debtor goes for a debt only case of “need” for money (or the benefit from such debt). Hence, it poses a limitation to them, in the scarcity/absence of which the next procedure cannot be taken up. It may also happen that required for such a debt, and options available can be concluded after a detailed analysis.

Conclusion

From a debtor’s view, Sundry Creditors and Accounts Payables as balance sheet items are added on the liabilities side of the balance sheet, while from a creditor’s view, Sundry Debtors or Accounts Receivable are added on the assets side.

Apart from payment by cash, a deal may require them to make payment in kind apart from the principle on the debt. Such deals are specific, customized, as per the size of the loan and relationship between the creditor and the Debtor. In such cases, payment terms also differ from general loan terms.

Recommended Articles

This has been a guide to Debtor and its definition. Here we discuss the meaning of debtors along with examples, advantages, disadvantages, and limitations. You can learn more about finance from the following articles –

  • Debtor Days Formula
  • Offset Account
  • What is Controlling Interest?
  • Hypothecation
0 Shares
Share
Tweet
Share
Primary Sidebar
Footer
COMPANY
About
Reviews
Contact
Privacy
Terms of Service
RESOURCES
Blog
Free Courses
Free Tutorials
Investment Banking Tutorials
Financial Modeling Tutorials
Excel Tutorials
Accounting Tutorials
Financial Statement Analysis
COURSES
All Courses
Financial Analyst All in One Course
Investment Banking Course
Financial Modeling Course
Private Equity Course
Venture Capital Course
Excel All in One Course

Copyright © 2021. CFA Institute Does Not Endorse, Promote, Or Warrant The Accuracy Or Quality Of WallStreetMojo. CFA® And Chartered Financial Analyst® Are Registered Trademarks Owned By CFA Institute.
Return to top

WallStreetMojo

Free Investment Banking Course

IB Excel Templates, Accounting, Valuation, Financial Modeling, Video Tutorials

* Please provide your correct email id. Login details for this Free course will be emailed to you

Book Your One Instructor : One Learner Free Class
Let’s Get Started
Please select the batch
Saturday - Sunday 9 am IST to 5 pm IST
Saturday - Sunday 9 am IST to 5 pm IST

This website or its third-party tools use cookies, which are necessary to its functioning and required to achieve the purposes illustrated in the cookie policy. By closing this banner, scrolling this page, clicking a link or continuing to browse otherwise, you agree to our Privacy Policy

Login

Forgot Password?

WallStreetMojo

Free Accounting Course

You will Learn Basics of Accounting in Just 1 Hour, Guaranteed!

* Please provide your correct email id. Login details for this Free course will be emailed to you

WallStreetMojo

Download Debtor Excel Template

New Year Offer - All in One Financial Analyst Bundle (250+ Courses, 40+ Projects) View More