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During the course of business, it's inevitable that you'll come across a note payable at some stage or another. When you do you must understand what it is, how it works, and what its requirements are.
To enable you to do this, this post will look at notes payable in more detail and show you what they are, what information they should contain, and how you should account for them.
What is a Note Payable?
A note payable, or promissory note , is a written agreement where a borrower obtains a specified amount of money from a lender and promises to pay it back over a specific period. In simple terms, a note payable is a loan between you and a lender. The lender can be an individual, a financial institution, or even a company.
In terms of the agreement, the interest rate may be fixed where you'll pay the same interest rate on the amount outstanding over the life of the loan. It could also be variable where the interest on the loan changes based on certain factors, such as a benchmark interest rate.
Typically, a note payable contains the following information:
- The amount to be paid in terms of the note.
- The interest rate applicable to the loan.
- The maturity date.
- Name of the maker or payer of the loan.
- Name of the payee.
- The signature of the person who issued the note with the date signed.
Understanding Note Payables
Examples of when you may need to use a note payable when:
- You buy materials in bulk from a supplier or manufacturer.
- You buy a building or equipment for your business.
- You loan a substantial amount of money from a bank or other financial institution.
Keep in mind, though, that these are just examples of where notes payable may be used and there are many more, depending on the type of business you have.
Also, notes payable can be classified as short-term or long-term liabilities. As such, when the note payable is due within 12 months from the date of signature, it's classified as a short-term liability. Furthermore, it is classified as a current liability on the company’s financial statements because it is paid within the company’s operating period. In contrast, if it's payable at a later date, it's classified as a long-term liability. Long-term liability is generally used to determine a company’s solvency.
Irrespective of whether it's a long-term or short-term liability, at any time when a note payable is issued, your bookkeeper or accountant should classify it as notes payable. In contrast, if you are owed an amount in terms of a promissory note, your account should classify it as a note receivable.
Here is an article about note payables in more detail.
Example of a Note Payable
With that in mind, let's look at an example of a note payable. Let's say Steve borrows $60,000 from Bob on 1 February 2021. Steve signs the note payable and agrees to pay Bob $60,000 two years later, or by the latest 31 January 2023. In addition, Steve also agrees to pay all Bob a 20% interest rate per year, payable every two months.
In Steve's balance sheet the note payable will be classified under long-term liabilities because the amount is due after 12 months. Remember, if the amount was due within 12 months, it would be a short-term liability and would be classified under current liabilities in the balance sheet.
In Steve's journal, the amount he receives in terms of the note payable, $60,000, will be debited to his cash account and will be credited to the notes payable account.
In addition, the interest on the note payable will need to be recorded every time interest is paid. To do this, Steve will set up an interest payable account under his current liabilities because the interest is paid short-term.
Here, Steve will credit the interest payable account with the amount of interest due, which, in this case, amounts to $2,000. He will also debit the interest expense account with the same amount.
When the interest is paid, Steve will debit the interest payable account and credit his cash account with $2,000. Keep in mind that every time interest is paid in terms of the note payable, Steve will need to make this entry.
Key Terms in a Note Payable
For a note payable to be a valid and enforceable legal agreement, it must include the following key terms:
- The loan amount.
- The repayment dates.
- The interest rate.
- Default terms.
- The names of both the lender and the borrower.
- The mailing address where each payment is mailed to.
Besides these terms, the lender may also require certain restrictive terms as part of the agreement. These can include, for instance, terms that prevent the paying of dividends to investors while any part of the loan is still outstanding.
Often, if these terms are breached, the lender then has a right to call up the loan, although it is possible for the lender to waive these breaches and continue to accept monthly or periodic payments from the borrower. Also, a note payable may require collateral as security for the loan.
It's also important to keep in mind that, for a note payable to be valid and enforceable, the borrower should print, sign, and date the note payable.
Image via Pexels by Andrea
Notes Payable vs. Accounts Payable
Although accounts payable and notes payable are both liabilities and represent amounts payable to businesses or financial institutions, there are some significant differences between the two.
Accounts payable are always short-term liabilities because they are due and payable within one year. These accounts payable involve credit received from businesses and vendors which require no written agreements and usually, no interest is charged on them. Accounts payable are typically day-to-day business expenses that businesses incur including supplies, utilities, goods, or professional services.
As said above, notes payable are written agreements that involve interest and can be classified as long-term or short-term liabilities.
Get Help With A Note Payable
Because notes payable often involve substantial amounts of money with interest, they must contain accurate and relevant information.
Fortunately, many financial services lawyers can help you when it comes to notes payable and give you the advice you need. If you need any more information on notes payable or advice regarding them, feel free to visit our website where you’ll find many other resources.
Meet some of our Note Payable Lawyers
Wendy C.
My legal practice is focused on business transactions like general corporate matters, fundraising, technology contract negotiation, blockchain, crypto or token analysis, and others. I hope to be a good asset to you and looking forward to finding out how I can be of help!
Michael M.
www.linkedin/in/michaelbmiller I am an experienced contracts professional having practiced nearly 3 decades in the areas of corporate, mergers and acquisitions, technology, start-up, intellectual property, real estate, employment law as well as informal dispute resolution. I enjoy providing a cost effective, high quality, timely solution with patience and empathy regarding client needs. I graduated from NYU Law School and attended Rutgers College and the London School of Economics as an undergraduate. I have worked at top Wall Street firms, top regional firms and have long term experience in my own practice. I would welcome the opportunity to be of service to you as a trusted fiduciary. In 2022 I was the top ranked attorney on the Contract Counsel site based upon number of clients, quality of work and top reviews.
Ryenne S.
My name is Ryenne Shaw and I help business owners build businesses that operate as assets instead of liabilities, increase in value over time and build wealth. My areas of expertise include corporate formation and business structure, contract law, employment/labor law, business risk and compliance and intellectual property. I also serve as outside general counsel to several businesses across various industries nationally. I spent most of my early legal career assisting C.E.O.s, General Counsel, and in-house legal counsel of both large and smaller corporations in minimizing liability, protecting business assets and maximizing profits. While working with many of these entities, I realized that smaller entities are often underserved. I saw that smaller business owners weren’t receiving the same level of legal support larger corporations relied upon to grow and sustain. I knew this was a major contributor to the ceiling that most small businesses hit before they’ve even scratched the surface of their potential. And I knew at that moment that all of this lack of knowledge and support was creating a huge wealth gap. After over ten years of legal experience, I started my law firm to provide the legal support small to mid-sized business owners and entrepreneurs need to grow and protect their brands, businesses, and assets. I have a passion for helping small to mid-sized businesses and startups grow into wealth-building assets by leveraging the same legal strategies large corporations have used for years to create real wealth. I enjoy connecting with my clients, learning about their visions and identifying ways to protect and maximize the reach, value and impact of their businesses. I am a strong legal writer with extensive litigation experience, including both federal and state (and administratively), which brings another element to every contract I prepare and the overall counsel and value I provide. Some of my recent projects include: - Negotiating & Drafting Commercial Lease Agreements - Drafting Trademark Licensing Agreements - Drafting Ambassador and Influencer Agreements - Drafting Collaboration Agreements - Drafting Service Agreements for service-providers, coaches and consultants - Drafting Master Service Agreements and SOWs - Drafting Terms of Service and Privacy Policies - Preparing policies and procedures for businesses in highly regulated industries - Drafting Employee Handbooks, Standard Operations and Procedures (SOPs) manuals, employment agreements - Creating Employer-employee infrastructure to ensure business compliance with employment and labor laws - Drafting Independent Contractor Agreements and Non-Disclosure/Non-Competition/Non-Solicitation Agreements - Conducting Federal Trademark Searches and filing trademark applications - Preparing Trademark Opinion Letters after conducting appropriate legal research - Drafting Letters of Opinion for Small Business Loans - Drafting and Responding to Cease and Desist Letters I service clients throughout the United States across a broad range of industries.
Amber M.
Amber Masters has over 9 years of experience as a contracts attorney, helping small businesses with an array of agreements, such as purchase agreements, master service agreements, and employment contracts. She has an extensive background in employment agreements for dentists, doctors, and other health care professionals. She is a highly rated and acclaimed estate planning attorney and personal finance expert, who has been featured on CNBC, NBC, and Yahoo Finance. She successfully launched and sold a fintech startup and can empathize with the issues small and mid-size businesses face. Licensed in Oklahoma and Arizona.
Kendall C.
Kendall is a data privacy attorney by trade, and is an active member of the Bar in Texas and Georgia. In litigation, he handled thousands of cases to final disposition in litigation throughout the United States, Latin America, & Europe. As corporate counsel, he guides companies through the marketing and advertising industry and, by extension, many other industries. Further, Kendall is an adherent to the Ben Hogan school of swing thought and, by natural extension, is a proponent of accurate wedge play through residential neighborhoods. He occasionally aspires to a career in turf management.
March 17, 2023
Alex F.
I am a small business attorney licensed to practice in Colorado and Texas. I focus on commercial lending and outside general counsel services.
March 24, 2023
Debra G.
I have been a business and real estate attorney for 38 years. I handle both transactional and litigation matters.
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Note Payable
Virginia
I loaned money to a 5013c organization, I want a lawyer to look over the contract, worried about them defaulting on it
I am worried about a 5013c organization defaulting on a promissary note, they do not seem to have their act together, want to have a lawyer look over the promissary note and get advice on what happens if they default on it
Donya G.
Sure. I take it they have not yet signed as yet? You can draft the agreement with some protections to ensure payment; however, you need to keep in mind that payment will always be contingent on whether they have money to pay or not. I am a contracts attorney and if you you would like my services, you can contact me on the contracts counsel website, or post your job on the website and attorneys will respond to your job. All the best Donya Gordon
Contracts
Note Payable
New York
I need to sue on an unpaid promissory note
The note was written back in March 2019 I hired an attorney and he has done nothing for me! I made tons of requests to try to settle out of court with this man and he just keeps blowing me off
Matthew S.
You need someone who will attempt to settle the matter for you and if that fails be prepared to sue on the note and take the necessary action to collect. This assumes the debtor has assets to collect against. It can take a while. I have had some folks pay relatively promptly, others several years. Communication between attorney and client is very important in this process. If you have no idea what is going on in your case you can get very anxious. I make sure you get consulted on each development and you get copies of each filing.
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Location: Florida
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Location: New Jersey
Turnaround: Less than a week
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