Definition: A creditor is a lender that is entitled to receive a payment from a borrower. The lender can be a business, organization, or individual. Basically, any entity that loans a business money or assets is considered a creditor.
What Does Creditor Mean?
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Since the borrower owns the creditor money, the law gives certain rights to the lender to protect his interests. For example, a borrower can’t simply take out a loan and stop making payments. The law allows creditors to take legal action against the debtor and require them to sell company assets to repay their obligations.
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Some of these rules change under bankruptcy laws, but the basics are still in tact. If a company declares bankruptcy and is forced to sell its assets creditors are first in line for payments. The lenders are allowed to recoup funds equal to their outstanding debts—not including any interest. If there is any money left over at the end of the liquidation, investors will also be paid.
This is why it is critical that creditors use the financial statements to assess the how creditworthy a company is. Being external users, lenders must rely on the balance sheet, income statement, and statement of cash flows to make their judgments about the company and its financial position. This is why audited financials are so important to creditors.
Banks and other lending institutions use liquidity ratios like the debt ratio, working capital ratio, and times interest ratio to analyze a company’s current financial state and assess the ability to pay additional obligations. Lenders are also concerned with the risk of default. Many times they first look at the ability a company has to pay obligations and then focus on the probability that the company will not pay its obligations.
After a borrower has met the creditors requirements, it can be issued a number of different kinds of loans including short-term debt like accounts payables or long-term debt like notes payable.
