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Need help with a Note Payable?
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.
In terms of the agreement, the interest rate may be fixed where you'll pay fixed interest on the amount outstanding over the life of the loan. It could also be variable where the interest on the loan changes in conjunction with the rate the lender charges its best customers.
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. In contrast, if it's payable at a later date, it's classified as a long-term liability.
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
Seasoned technology lawyer with 22+ years of experience working with the hottest start-ups through IPO and Fortune 50. My focus is primarily technology transactions with an emphasis on SaaS and Privacy, but I also provide GC services for more active clients.
I am a California-barred attorney specializing in business contracting needs. My areas of expertise include contract law, corporate formation, employment law, including independent contractor compliance, regulatory compliance and licensing, and general corporate law. I truly enjoy getting to know my clients, whether they are big businesses, small start-ups looking to launch, or individuals needing legal guidance. Some of my recent projects include: -drafting business purchase and sale agreements -drafting independent contractor agreements -creating influencer agreements -creating compliance policies and procedures for businesses in highly regulated industries -drafting service contracts -advising on CA legality of hiring gig workers including effects of Prop 22 and AB5 -forming LLCs -drafting terms of service and privacy policies -reviewing employment contracts I received my JD from UCLA School of Law and have been practicing for over five years in this area. I’m an avid reader and writer and believe those skills have served me well in my practice. I also complete continuing education courses regularly to ensure I am up-to-date on best practices for my clients. I pride myself on providing useful and accurate legal advice without complex and confusing jargon. I look forward to learning about your specific needs and helping you to accomplish your goals. Please reach out to learn more about my process and see if we are a good fit!
I am a NY licensed attorney experienced in business contracts, agreements, waivers and more, corporate law, and trademark registration. My office is a sole member Law firm therefore, I Take pride in giving every client my direct attention and focus. I focus on getting the job done fast while maintaining high standards.
A twenty-five year attorney and certified mediator native to the Birmingham, Alabama area.
Longtime corporate real estate counsel with specialities in commercial leasing, contracts, corporate governance, and general small business/startup/entrepreneurship legal issues.
I absolutely love helping my clients buy their first home, sell their starters, upgrade to their next big adventure, or transition to their next phase of life. The confidence my clients have going into a transaction and through the whole process is one of the most rewarding aspects of practicing this type of law. My very first class in law school was property law, and let me tell you, this was like nothing I’d ever experienced. I remember vividly cracking open that big red book and staring at the pages not having the faintest idea what I was actually reading. Despite those initial scary moments, I grew to love property law. My obsession with real estate law was solidified when I was working in Virginia at a law firm outside DC. I ran the settlement (escrow) department and learned the ins and outs of transactions and the unique needs of the parties. My husband and I bought our first home in Virginia in 2012 and despite being an attorney, there was so much we didn’t know, especially when it came to our HOA and our mortgage. Our real estate agent was a wonderful resource for finding our home and negotiating some of the key terms, but there was something missing in the process. I’ve spent the last 10 years helping those who were in the same situation we were in better understand the process.
Samantha has focused her career on developing and implementing customized compliance programs for SEC, CFTC, and FINRA regulated organizations. She has worked with over 100 investment advisers, alternative asset managers (private equity funds, hedge funds, real estate funds, venture capital funds, etc.), and broker-dealers, with assets under management ranging from several hundred million to several billion dollars. Samantha has held roles such as Chief Compliance Officer and Interim Chief Compliance Officer for SEC-registered investment advisory firms, “Of Counsel” for law firms, and has worked for various securities compliance consulting firms. Samantha founded Coast to Coast Compliance to make a meaningful impact on clients’ businesses overall, by enhancing or otherwise creating an exceptional and customized compliance program and cultivating a strong culture of compliance. Coast to Coast Compliance provides proactive, comprehensive, and independent compliance solutions, focusing primarily on project-based deliverables and various ongoing compliance pain points for investment advisers, broker-dealers, and other financial services firms.