Notes Payable

What is Notes Payable?

Notes Payable are written agreements (promissory notes) in which one party agrees to pay the other party a certain amount of cash. Alternatively put, a note payable is a loan between two parties.

The following information is contained in a note payable:

• The amount to be paid
• The interest rateEffective Annual Interest RateThe Effective Annual Interest Rate (EAR) is the interest rate that is adjusted for compounding over a given period. Simply put, the effective applied to the loan
• The maturity date
• Name of the maker of the note (payer)
• Name of the payee
• The signature of the person who issued the note with the date signed.

Notes Payable on a Balance Sheet

Notes payable appear as liabilities on a balance sheetBalance SheetThe balance sheet is one of the three fundamental financial statements. These statements are key to both financial modeling and accounting. The balance sheet displays the company’s total assets, and how these assets are financed, through either debt or equity. Assets = Liabilities + Equity. Additionally, they are classified as current liabilitiesCurrent LiabilitiesCurrent liabilities are financial obligations of a business entity that are due and payable within a year. A company shows these on the balance sheet. A liability occurs when a company has undergone a transaction that has generated an expectation for a future outflow of cash or other economic resources. when the amounts are due within a year. When a note’s maturity is more than one year in the future, it is classified with long-term liabilities.

An example of different accounts on a balance sheet:

Notice how notes payable can be short-term or long-term in nature.

Example

John borrows $100,000 from Michelle on January 1, 2017. John signs the note and agrees to pay Michelle $100,000 six months later (January 1 through June 30). Additionally, John also agrees to pay Michelle a 15% interest rate every 2 months.

The journal entries would be as follows:

The Difference Between Accounts Payable and Notes Payable

The concept of accounts payable and notes payable are often mixed up. A definition of both of these terms along with their respective attributes are detailed below:

Accounts Payable

Accounts payable is an obligation that a business owes to creditors for buying goods or services. Accounts payable do not involve a promissory note, usually do not carry interest, and are a short-term liability (usually paid within a month).

Notes Payable

These are written agreements in which the borrower obtains a specific amount of money from the lender and promises to pay back the amount owed, with interest, over or within a specified time period. It is a formal and written agreement, typically bears interest, and can be a short-term or long-term liability, depending on the note’s maturity time frame.

Creating an Enforceable Promissory Note

To create an enforceable promissory note, the following elements must be included:

• The loan amount
• The repayment dates
• The interest rate
• Default terms
• The names of both the lender and the borrower
• Mailing address where each payment is mailed to
• The borrower should print, sign, and date the promissory note

Notes Receivable

Both the items of Notes Payable and Notes Receivable can be found on the Balance SheetBalance SheetThe balance sheet is one of the three fundamental financial statements. These statements are key to both financial modeling and accounting. The balance sheet displays the company’s total assets, and how these assets are financed, through either debt or equity. Assets = Liabilities + Equity of a business. While Notes Payable is a liability, Notes Receivable is an asset. Notes Receivable record the value of promissory notes that a business should receive, and for that reason, they are recorded as an asset. NP is a liability which records the value of promissory notesPromissory NoteA promissory note refers to a financial instrument that includes a written promise from the issuer to pay a second party – the payee – a specific sum of money, either on a specific future date or whenever the payee demands payment. The note should include any terms that relate to the indebtedness, including when and that a business will have to pay. This is analogous to accounts receivable vs. accounts payableAccounts Payable vs Accounts ReceivableIn accounting, accounts payable and accounts receivable are sometimes confused with the other. The two types of accounts are very similar in the way they are recorded but it is important to differentiate between accounts payable vs accounts receivable because one of them is an asset account and the other is a.

Additional Resources

CFI’s mission is to help anyone in the world become a confident financial analyst through the CFI Financial Modeling & Valuation AnalystFMVA® CertificationJoin 350,600+ students who work for companies like Amazon, J.P. Morgan, and Ferrari credential program.  To continue learning and advancing your career, these additional CFI resources will be helpful:

• Accounts PayableAccounts PayableAccounts payable is a liability incurred when an organization receives goods or services from its suppliers on credit. Accounts payables are expected to be paid off within a year’s time, or within one operating cycle (whichever is longer).  AP is considered one of the most liquid forms of current liabilities
• Bonds PayableBond PayablesBonds payable are generated when a company issues bonds to generate cash. Bonds payable refers to the amortized amount that a bond issuer holds on its balance sheet. It is considered a long-term liability
• Projecting Balance Sheet ItemsProjecting Balance Sheet Line ItemsProjecting balance sheet line items involves analyzing working capital, PP&E, debt share capital and net income. This guide breaks down how to calculate
• Three Financial StatementsThree Financial StatementsThe three financial statements are the income statement, the balance sheet, and the statement of cash flows. These three core statements are intricately