Businesses borrow money in different ways. They might, for example, receive goods and services on credit and pay the invoice 30 or 60 days later. Or, they might take out a small business loan and repay the principal (plus interest) in monthly installments over several years.
Both types of debt are considered liabilities. In small business accounting, however, they are treated differently. The first example is considered an account payable, while the second is generally considered a note payable.
Read on for a closer look at accounts payable vs. notes payable, including how each accounting system works and how these accounts are both similar and different.
Key Points
• Both notes payable and accounts payable are liabilities but differ in terms of formality, duration, and interest.
• Notes payable are formal, long-term debts with interest; they are typically issued when obtaining a loan from a bank.
• Accounts payable are short-term, informal debts to suppliers, often due within 30 to 90 days, without interest.
• Notes payable involve promissory notes and are used for larger capital needs, while accounts payable are for regular operational expenses.
• Proper management of both accounts is crucial for maintaining good business credit
What Are Accounts Payable?
Accounts payable refers to the money a company owes to its suppliers, contractors, and partners. These debts are short-term (often paid within 30, 60, or 90 days) and are typically recurring, since companies tend to use the same trusted suppliers on a regular basis.
Generally, accounts payable are informal agreements and are generated as part of the operating cycle of the business.
How Accounts Payable Works
Typically with accounts payable, you receive goods or services before paying for them. For example, you might order office supplies, receive them within a week, but have a month or two to pay the invoice. Accounts payable are recorded as a current liability on the company’s balance sheet.
In terms of day-to-day accounting, an account payable is considered a liability account that typically has a credit balance. When your business pays an invoice to a creditor, cash is credited while the accounts payable account is debited.
While there is typically no interest charged on accounts payable, there may be a fee assessed if the invoice is not paid by the invoice due date.
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Benefits of Accounts Payable
Buying goods and services as needed on credit gives businesses an advantage over competitors that may have to pay upfront.
Using trade credit also allows your business to be more flexible, adapting to market demands and seasonal variation so that you have a constant supply of goods even when your finances aren’t stable. Without needing to pay cash upfront, for example, a business can stock up in time for peak demand, even if cash flow is currently low.
However, these expenses can add up and need to be organized in a way that allows the process of making payments as efficient as possible.
A good accounts payable system helps you keep track of operating expenses and ensures invoices are paid on time. This can help your firm maintain good relationships with creditors and vendors, and also have a positive effect on your company’s credit rating.
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What Are Notes Payable?
Like accounts payable, notes payable refers to debt on the balance sheet. The main difference is that these debts are considered formal loans where you need to manage not only principal but interest. They also tend to be longer term than accounts payable, often longer than a year.
Notes payable generally include different types of small business loans. A note payable may also be issued when a company purchases a vehicle or acquires a building for the business.
Unlike accounts payable, notes payable arise from formal lending agreements, such as promissory notes, that typically spell out the terms of repayment, including the principal amount, interest rate, and payments schedule.
Notes payable are independent of the business cycle, so they don’t necessarily change with the company’s business volume. And since they have an interest expense associated with them, they are not cost-free.
How Does Notes Payable Work?
Notes payable involve the payment of money owed to a financial institution or other creditors. They are recorded as long-term liabilities on the balance sheet, since they generally have repayment periods that are one year or longer.
The way a note payable works in the accounting process is that you debit your cash account for the loan amount received and credit your notes payable account to reflect the liability. When you repay the loan, you would then debit your notes payable account and credit your cash account for the payment amount. For the interest that accrues, you will need to record the expense in your interest expense and interest payable accounts.
Benefits of Notes Payable
Notes payable allow your business to access larger amounts of capital that it can with accounts payable. Long-term notes payable can provide the capital to invest in future growth, product development, and innovation, while freeing up current assets for current operations.
And unlike taking on investors, a note payable allows you to maintain ownership and full control over your company.
Notes payable accounting also has benefits. Maintaining proper accounting of notes payable ensures you make timely payments of principal and interest on your debt. This helps your business maintain good relationships with lenders, while also helping you build business credit.
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Notes Payable vs. Accounts Payable
Accounts payable and notes payable have some similarities, but also significant differences. Here’s a look at how they compare.
Similarities
Both accounts payable and notes payable deal with a business’s debts. They are listed as liabilities on the balance sheet. And as they are paid down or paid off, they are debited from the liabilities and credited toward cash or another asset.
Both types of accounts may also list payment terms, which helps you understand when payment is due.
Sometimes these two types of debt also intersect. If a company faces a strong probability of running out of cash and being unable to make short-term payments to its accounts payable accounts, its creditors may request a promissory note for the leftover balance. The account payable is then converted into a note payable account as a new entry. This gives the company more time to pay off the debt, while the creditor can earn interest.
Differences
The main difference between these two types of accounts is that accounts payable tends to be informal and short-term, without a lot of specific obligations outlined for the specific supplier. Notes payable, on the other hand, tend to be longer-term, include more stipulations, and are always formal written contracts.
Another key difference: Unlike accounts payable, notes payable have an interest component and the interest expense is usually considered separate to the loaned amount.
Also, while accounts payable can be converted into notes payable, notes payable are not typically converted into accounts payable.
| Accounts Payable | Notes Payable |
|---|---|
| Short-term debts | Long-term debts |
| Doesn’t include principal and interest | Includes principal and interest |
| No promissory note | Promissory note |
| Payable to supplier, vendor, or contractor | Payable to credit companies and financial institutions |
| Informal agreement | Formal agreement |
| Can be converted into a note payable | Can’t be converted into an account payable |
The Takeaway
The terms “notes payable” and “accounts payable” are commonly used to describe how finances are recorded in business. While they sound similar and are sometimes used interchangeably, they are not the same thing.
Notes payable are used as a liability account to record a debt payback, while accounts payable is used when a company buys goods or services on credit.
Both types of accounts help ensure that a business keeps track of all of its liabilities and pays all its debt obligations on time. This is important for maintaining a good reputation in your industry, as well as building your business credit, which can help you qualify for loans and credit with attractive rates and terms in the future.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
How are notes payable and accounts payable different?
Notes payable are written promissory notes that a company receives when it borrows money from a lender, generally financial institutions and financing or credit companies.
Accounts payable, on the other hand, are debts due to vendors, suppliers, or business partners, typically due in 30, 60, or 90 days.
What is an example of a note payable?
A note payable occurs when a company borrows money under a formal agreement. For example, let’s say a business takes out a $50,000 loan from a bank and agrees to repay it over five years. The loan terms, repayment schedule, and interest rate are documented in a promissory note. The company records the amount borrowed as a note payable on its balance sheet, reflecting its obligation to repay the debt under the agreed terms.
How do notes payable and accounts receivable differ?
Notes payable accounts are used when a business takes out a loan from a credit company or financial institution, whereas accounts payable is used when a company buys goods or services on credit from a supplier or vendor.
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