Have you ever lent money to a friend and fallen into a sticky situation asking for the money back?
You could’ve sworn you handed them a $20 bill at the cash-only bar, but they only sent you $10 via an app later that day. By now, the happy hour margaritas have gotten to your head, and you can’t remember the amount you lent to them in the first place.
Had you and your pal signed a written lending agreement, there would be no confusion over the amount or the time you expected payment back from them. You could even try to charge them interest. Although that might not be a great way to sustain a friendship, it is what businesses do on a larger scale when it comes to financing through notes payable.
What are notes payable?
A note payable is a written agreement between two parties specifying the amount of money the one party is borrowing from the other, the interest rate it will pay, and the date when the full amount is due.
Note payable definition
A written agreement between two parties stating that one will pay the other back at a later date.
The written document itself a type of promissory note, or legal document in which one party promises to pay another. This makes it a form of debt financing somewhere in between an IOU and a loan in terms of written formality.
Short-term vs. long-term notes payable
Short-term notes payable are due within a year, whereas long-term notes payable are due in over one year. They are therefore categorized differently on the company balance sheet.
Because they are money owed by the company, both short and long-term notes payable are considered liabilities. Short-term notes payable fall under current liabilities, and long-term notes payable fall under long-term liabilities.
Another difference between short-term and long-term notes payable is whether or not they are accounted for in a company’s capital structure. While they are both a form of debt capital, only long-term liabilities (and therefore long-term notes payable) are considered a part of a company’s capital structure.
Notes payable vs notes receivable
Notes payable and notes receivable are the same thing. For the borrower, they are called notes payable, and for the lender they are called notes receivable. If the lender was to categorize notes receivable on their own balance sheet, it would be considered either a current or non-current asset depending on the term length.
Notes payable vs accounts payable
Notes payable are oftentimes confused with accounts payable, and while they are both technically company debt, they are different categories. We can think of accounts payable as very short-term debts the company might owe as payment for goods or services from another party. They are typically paid off within the span of a month, whereas notes payable could have terms as long as several years.
Notes payable are a popular way to finance a brand new company. For a small business or a startup, notes payable may be a way to get off the ground, even if they’re just borrowing a small amount of money. You might even want to use them in your personal finances. After all, nobody wants to end a friendship over a margarita.