Jump to Section
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
High quality work product at affordable prices.
Full-service boutique law firm providing personalized services in business law, trademarks, and real estate closings/title work.
Providing attentive service since 1992, Mike has established himself as a go-to source for legal answers throughout the Southern New Jersey region.
Respected, driven, ethical, and high energy legal and business professional with strong focus on litigation, contracts and compliance issues. Critical management experience includes client development, developing core initiatives, and forecasting risk in major corporations. Strong legal research, analytical and problem solving skills with demonstrated adaptability in a multifaceted legal practice including delivering high value results in a Fortune 10 environment. Core competencies include: Tactical and strategic legal direction and support to clients which includes contract negotiation, drafting and review, business planning, and a passion for relationship management. Excellent legal research, writing, analytical and problem solving skills including legal training and compliance with regulatory requirements and corporate policies. Coordinates with in-house legal and business resources for team building with excellent verbal communication skills, coaching, and leadership.
I am a sole practitioner who has been in practice for over 25 years. I have represented many small businesses during this time. Let me bring my expertise to your business.
Diana is a registered patent attorney and licensed to practice law in Florida and in federal courts in Florida and in Texas. For nearly a decade, Diana has been known as the go-to brand builder, business protector, and rights negotiator. Diana works with individual inventors, startups, and small to medium-sized closely held business entities to build, protect, and leverage a robust intellectual property portfolio comprising patents, trademarks, copyrights, trade dress, and trade secrets.
Brandon is a Texas Super Lawyer®, meaning he is among the top 2.5% of attorneys in his state. He has designed his practice to provide a unique ecosystem of legal support services to business and entrepreneurs, derived from his background as a federal district law clerk, published biochemist, and industry lecturer. Brandon is fluent in Spanish, an Eagle Scout, and actively involved with the youth in his community. He loves advocating for his clients and thinks he may never choose to retire.