Debtor Meaning
A debtor is a borrower who is liable to pay a certain sum to a credit supplier such as a bank, credit card company or goods supplier. The borrower could be an individual like a home loan seeker or a corporate body borrowing funds for business expansion.
Normally, borrowers must repay their debt along with additional interests to compensate the lender.
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Key Takeaways
- A debtor is defined as an individual or firm that owes a particular amount to a lender, payable at a future date or period. A creditor is the supplier of a loan or credit facility and usually makes money out of interest on the debt.
- In accounting, a debtor is listed in the balance sheet under assets as it denotes a due revenue, which is an asset for a business.
- Fair Debt Collection Practices Act (FDCPA) is a law that prevents exploitation of the borrowers. Also, if a borrower becomes bankrupt or fails to repay the borrowed money, the lender can resort to a lawsuit, penalty or other legal action.
Debtor Explained
Debtors are common in business and everyday life. For example, if you have borrowed money from a bank to buy a house or study abroad, you are a debtor. The bank is the creditor as it has loaned the money. Other examples of debtors include businesses and governments that borrow funds to meet their financial requirements. Based on the debt type, lenders usually charge compensation for lending.
For example, if it is a loan, the lender will charge interest on the due amount. Here, the borrower must repay the loan along with interest. In addition, most loan lenders ask for collateral as a backup in case they fail to recover the debt. Conversely, when one buys goods on credit, there are often no interests involved as it is provided on the borrower’s reputation.
In debts, one must exercise caution while acquiring or extending a loan. Granted that borrowing money helps people and entities meet their financial needs. But it is not easy to seek loans as most institutions require a good credit score which is hard to arrange for many low-income groups.
Moreover, accumulating interests make repayments difficult for borrowers, putting financial constraints on them. Many times, people lose their collateral as well upon failing to repay the debt. Consequently, if a borrower fails to repay, the lender may lose the loaned amount, especially if the borrow files for bankruptcy. As such, one must deal in debts after thorough contemplations regarding their alternatives.
Debtor Examples
- Consumer loans – Borrowing money from banks or financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more to purchase a house, finance education, or for a trip abroad, etc.
- Business loans – Businesses borrow long and short term debts to meet operational requirements. Common long-term borrowing examples include bank loans, securities such as debentures and bonds, etc. In bonds, the issuer is the borrower. Short-term needs are fulfilled using facilities like bills of exchangeBills Of ExchangeBills of exchange are negotiable instruments that contain an order to pay a certain amount to a particular person within a stipulated period of time. The bill of exchange is issued by the creditor to the debtor when the debtor owes money for goods or services.read more, letters of creditLetters Of CreditA letter of credit is a payment mechanism in which the issuer's bank gives an economic guarantee to the exporter for the agreed payment amount if the buyer defaults. In international trade, buyers employ LC to reduce credit risk.read more, payday loans, etc.
- Entities – Likewise, entities like non-profit organizationsNon-profit OrganizationsA not-for-profit organization refers to a legal entity that isn't created to generate profits or revenue for its owners but aims at social, educational, religious or public welfare and service. Such an organization is tax-exempted and run through donations or any other income it makes.read more, communities, etc., borrow money for different requirements.
- Government and nations – The government issue bonds such as a T-bond to raise funds from the public and finance its development activities. An important source of external borrowing for a nation is International Monetary Fund (IMF). Many nations borrow funds from the IMFIMFThe full form of IMF is International Monetary Fund. It is an organization of international recognition based in Washington DC comprising of 189 countries working towards international monetary cooperation with an objective of establishing economic stability across the globe.read more and other countries to keep its economy running.
- Credit facility – Businesses acquire goods on credit from a supplier based on their reputation of making timely payments. Other credit facilitiesCredit FacilitiesCredit Facility is a pre-approved bank loan facility to businesses allowing them to borrow the capital amount as & when needed for their long-term/short-term requirements without having to re-apply for a loan each time. read more include credit cards, prepaid services such as prepaid electricity meters, prepaid taxis, etc.
Accounting of Debtor Account
Businesses often supply goods or services to a client in advance before receiving their payment. Therefore, in accounting, the client who owes money to a business for purchasing its goods or services on credit is recorded as a debtor account.
A debtor account is an asset as it denotes a pending revenue from a credit sale. Therefore, it is put under the debit side of accounting books, such as the balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more.
Debtor days is the number of days a company takes to recover cash from its credit sales. Too many account receivablesAccount ReceivablesAccounts receivables refer to the amount due on the customers for the credit sales of the products or services made by the company to them. It appears as a current asset in the corporate balance sheet.read more and longer debtor days will affect a company’s availability of cash. In such cases, it won’t be easy to manage the company’s working capital requirements.
Types of Debt Interests with Calculations
We have discussed below the types of interests a debtor must pay along with the owed amount.
1. Repayment of debt without interest
Here, only the borrowed sum needs to be repaid as it does not accrue any interests. Examples include bills receivable by a company.
Calculation – George took a loan of $500 from his friend and promised to return the amount in a week. His friend did not charge any interest, and so George only repaid $500 after 6 days.
2. Repayment of debt with simple interest
When the borrower takes a loan at an interest chargeable with the simple interest method, the outstanding loan amount is evaluated as:
Due amount = Simple Interest (SI) + Principal
SI = (P×R×T)/100
Where A is the outstanding amount;
- P is the principal amount;
- R is the annual rate of interest; and
- T is the time converted in years.
Calculation – S borrowed $6000 from a bank at the rate of 10% per annum. The time period to repay the loan is 5 years; calculate the due amount using simple interestSimple InterestSimple interest is interest determined on a person's principal amount borrowed. It is determined by multiplying the principal amount borrowed by the interest rate and the time period for which interest is charged.read more.
- SI = (6000 x 10 x 5) / 100 = $3000
- Due amount = $6000 + $3000 = $9000
3. Repayment of debt with compound interest
If the creditor allows credit to be repayable with a compound interestCompound InterestCompound Interest is the interest earned from the initial Principal & the previously accumulated Interest amount. This is also known as “Interest on Interest” & it is always higher than the Simple Interest. read more, the total amount due is computed as:
A = P (1 + r/100)^(t)
Where A is the outstanding amount;
- P is the principal amount;
- R is the annual rate of interest; and
- T is the time converted in years.
Calculation – T deposited a sum of $5000 in ABC bank. The bank promised to repay the sum after five years with a compound interest of 8% per annum.
What is the total outstanding amount payable by the bank after five years?
- A = [5000 (1 + 8/100) ^ 5]
- A = $7346.64
Thus, the total outstanding sum payable by the bank is $7346.64.
Debtor Prison and Legal Protection
Earlier, the US and UK had debtor prisons that imprisoned those who couldn’t repay their debts or were behind schedule. They were put behind bars even for the smallest amounts of debts. In the 19th Century, the prisons were banned and branded unconstitutional in the US. Yet, as per a 2020 study, over 3000 borrowers were issued an arrest warrant over payday loans, vehicle title, and other expensive lendings.
Debtor protection laws such as the Fair Debt Collection Practices Act (FDCPA) have been around for a while. Whenever unlawful imprisonment of debt holders surface, authorities take stricter actions to prevent such practices. The FDCPA also informs borrowers of their rights, what collectors can do and what they are prohibited against.
It also helps address the grievances of borrowers. Moreover, facilities like a debtor in possession financing allow borrowers to undertake business operations in a mortgaged building despite declaring bankruptcy. The idea is to continue functioning to pay off the debt eventually.
However, there are laws to safeguard creditors, too, especially with absconding borrowers or criminal offenders. An example is Nirav Modi’s alleged involvement in the $2.2 billion defrauding of a reputed Indian bank. The accused used illegal guarantees by rogue bank staff to raise credits from other banks and fled from the country.
FAQs
A debtor is a borrower of funds or a credit facility, and a creditor is the lender of funds who extends a credit facility.
A debtor is a current asset recognized as accounts receivable for a company since the due amount will be received at a specific date in future using cash, kind or cheque.
They are the clients or customers who have taken the company’s delivery of goods or services but haven’t made an immediate payment. Instead, they promise to pay the due amount at a future date or period.
The customers who make a credit purchase of products or services and don’t pay immediately for the same are considered the company’s borrowers, such as credit cardholders.
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