Notes Payable

What are notes payable?

A note payable is a written promissory note stating that a company owes money to an external lender or creditor. A note payable is a legal contract outlining the specific loan terms.

Notes payable differ from standard bills in several ways. They typically involve larger sums, longer repayment periods, and the accrual of interest, and a formal legal agreement documents them.

What are the key elements of notes payable?

• Principal: The original amount of money that is borrowed.
• Interest rate: The percentage charged on the principal. This interest is calculated annually.
• Maturity date: The date the balance and any accrued interest is due.
• Installment payments: Often, regular payments over time, this includes both principal repayment and interest.
• Collateral (not for all notes): This may be secured by the borrower’s assets to reduce risk to the lender.

Types of notes payable.

• Short-term notes payable: Generally due within one year or less. Short-term notes payable are usually for short-term financing needs like purchasing inventory or covering seasonal cash flow variations.
• Long-term notes payable: Where the maturity date extends beyond one year, long-term notes payable are generally used to finance long-term investments in equipment, property, or company expansion.
• Secured notes payable: Backed by collateral such as company assets, these give the lender extra security in case the borrower defaults.
• Unsecured notes payable: Issued based solely on the borrower’s creditworthiness, carrying slightly higher interest rates to compensate for the lender’s increased risk.

Accounting considerations for notes payable.

• Issuance: When a note payable is issued, it is recorded as a liability on the Balance Sheet under “Notes Payable” and an entry under “Cash” for the received amount.
• Interest accrual: The accrued interest is recorded on the Income Statement as an “Interest Expense.”
• Payments: The notes payable liability is reduced with payments. Interest expenses are recorded accordingly.

Importance of notes payable management.

Notes payable are part of a company’s financial obligations, so they can directly impact its debt ratios.

That means careful management of notes payable is crucial to maintaining healthy cash flow, optimizing interest expenses, and ensuring compliance with loan agreements.

Finance departments should stay on top of the following:

• Impact on financial ratios: Notes payable directly affect your debt-to-equity ratio and other metrics, which are crucial indicators for creditors and investors when they look at your company’s financial health.
• Cash-flow planning: To make accurate cash flow productions, you must carefully manage the timing and amounts of any accounts payable obligations.
• Interest expense budgeting: Interest expenses impact profitability. You must factor this in when budgeting and forecasting expenses.
• Compliance: Notes payable may contain covenants or restrictions that the company must comply with, such as maintaining specific financial ratios.

Notes payable best practices.

Best practices to effectively manage notes payable include:

• Negotiate terms: Secure the best possible interest rates and repayment schedules.
• Maintain accurate records: Meticulous record keeping of notes payable terms, payment schedules, and interest accrual is essential for reporting and financial analysis.
• Consider refinancing: If interest rates decline, look at refinancing existing notes payable to secure lower rates.
• Strategic use: Evaluate if notes payable are the best financing option based on the company’s specific needs and financial goals.

How Airbase helps with notes payable.

Here’s how Airbase accounts payable automation helps with managing notes payable and ensuring timely payments.

• Payment scheduling: Airbase lets you schedule payments in advance to align with due dates. This eliminates the risk of manual errors or overlooking payments.
• Vendor payment options: Airbase offers multiple payment methods (ACH, virtual cards, checks) so you can choose the most appropriate way to pay your vendors based on the terms of your notes payable.
• Automated approvals: You can set up multi-level approval workflows customized to your company’s policies. This speeds up the review of notes payable and ensures proper oversight before payments are made.
• Real-time visibility: Airbase provides clear dashboards and reporting on payables. This gives you an up-to-date picture of upcoming notes payable, cash flow, and overall financial status.