What are debtors?

What debtors means

When you invoice a customer on credit, they become a debtor until they pay. In UK accounts, debtors are a current asset and usually include:

• trade debtors: customers with unpaid invoices, called accounts receivable in Xero and QuickBooks
• prepayments: costs paid in advance for a later period, such as annual insurance
• other debtors: a VAT refund due from HMRC, or a director's loan the director owes the company

Example

A consultancy invoices £540,000 a year, all on credit. At its year end customers owe £88,800.

Debtor days = trade debtors ÷ credit sales × 365

£88,800 ÷ £540,000 × 365 = 60 days. On average, customers take two months to pay, even though invoices say 30 days.

If the consultancy got that down to 40 days, debtors would fall to about £59,200, freeing up nearly £30,000 of cash without earning a penny more.

Why it matters for your business

Unpaid invoices are profit you have been taxed on but not been paid for. Under accrual accounting, an invoice counts as income when issued, so a business with high debtors can owe Corporation Tax or VAT on money it has not received. (Cash accounting for VAT avoids that for businesses under £1.35 million turnover.)

Habits that help:

• invoice the day work is done, with clear terms and a due date
• offer easy online payment links from your accounting software
• send automatic reminders before and after the due date
• review an aged debtors report every week
• take deposits or stage payments on larger jobs

Debts that will clearly never be paid should be written off as bad debts, and VAT on them can be reclaimed after six months.

Debtors vs creditors

Debtors owe you; creditors are owed by you. Managing the gap between the two is the heart of working capital.

Bad debts and provisions

At the year end, review each old invoice. If a customer has gone into liquidation, write the debt off. If payment looks doubtful, a specific provision reduces debtors and profit in the accounts. For Corporation Tax, specific write-offs and provisions are usually allowable, but a general percentage provision is not.