Notes payable is a written obligation to pay a certain sum of money, either with or without interest, within a particular time. Notes payable are legal obligations in contrast to accounts payable and normally are in written form of a promissory note. Companies greatly depend on them to fund their operations, manage cash flow or even carry out an expansion.
Key Features of Notes Payable
- Notes payable- There are certain characteristic details of notes payable
- Principal amount: The amount which is firmed by way of loan.
- Interest rate: The charge levied on loan.
- Maturity date:The date a debt has to be paid off.
- Terms of payment: either single sum, or by instalments.
They may be short-term ( seventeen days or less ) or long-term (over one year). The short-term notes feature in the current liability section of the balance sheet and the long-term notes in the non-current liabilities section of the balance sheet.
How Notes Payable Work
When company issues a note, it will repay money with interest. Taking an example, when business is borrowing 20000 at 8 per cent to be paid after one year, the actual amount to be returned will be 21600.
Accounting transactions normally resemble the following:
- Debit Notes Payable, Credit Cash.
- Accrual: Interest: Debit Interest Expense Credit Interest Payable.
- Repayment: Debit Notes Payable, Interest Payable and Credit Cash.
Advantages and Disadvantages
Benefits:
- Is a source of swift funding without losing out to investors
- Presents Flexible repayment plans
- Increases stability with creditors.
Risks:
- Adds interest burden to the costs.
- Debt financing is listed on the balance sheet increase.
- Can easily lead to loss of the business through default.
Notes Payable vs. Other Liabilities
- Accounts Payable: Informal, short term, interest free.
- Bonds Payable Larger, long term, issues to a variety of investors.
- Loans: You may or may not have promissory notes.
In a nutshell, the accounts payable is similar to when someone borrows a friend his or her pen, whereas, the notes payable is like borrowing cash at an interest rate.
Practical Uses of Notes Payable
Notes payable are used by businesses:
- Fund increase projects such as acquisition of equipment.
- Write checks to meet cash deficit income slumps
- Support business-to-business lending that do not involve banks.
- They are also used by startups in their initial-stage financing prior to equity raising.
Impact on Financial Statements
- Balance Sheet: This is reported as debts.
- Income Statement The interest expense lowers the profit.
- Cash Flow Statement Repayments is treated as part of financing activities.
Conclusion
Notes payable may seem quite ordinary liabilities but they can be serious business tools. They help default companies give a structure that imposes accountability and gives these companies ready access to financing. Those who run businesses should, however, manage them properly as failures to classify liabilities appropriately and count the interests can backfire. Notes payable hold growth and responsibility in good balance when properly used.
