Many businesses sell their products or services to customers on credit. They simply send an invoice to the customer after the sale and the customer (theoretically) pays it. However, some transactions are better completed with a more formal promise to pay, called a promissory note. When a promissory note is accepted, a business records the amount due on its accounting books as a note receivable, meaning an asset.
Companies of all sizes and industries use notes receivable, which benefit both sides of the purchase equation. Note receivable “makers” — often but not always a customer — get extra time to pay, and note holders receive interest income plus a better likelihood they’ll get paid due to the firmer commitment that a note formalizes. However, companies must use the accrual method of accounting and follow some specific rules when recording notes receivable. This can make bookkeeping cumbersome, especially for companies that hold multiple notes receivable.
Notes receivable are asset accounts tied to an underlying promissory note, which details in writing the payment terms for a purchase between the “payee” (typically a company, and sometimes called a creditor) and the “maker” of the note (usually a customer or employee, and sometimes called a debtor). Notes receivable can be between a business and any other party — another business, a financial institution or an individual. Most often, they come about when a customer needs more time to pay for a sale than the standard billing terms. As a trade-off for agreeing to slower payment, payees charge interest and require a signed promissory note for legal purposes. Employee cash advances where the company asks the employee to sign a promissory note are another way notes receivable come about.
Notes receivable have a higher probability of payment than purchases made on simple credit, which are known as open trade receivables. That’s because of the signed promissory note, which can be presented as evidence in a legal proceeding. In addition, notes receivable can potentially be sold to third parties. By reducing unpaid, “bad” debts, collecting interest income and facilitating contract sales, notes receivable can be a tool for enhancing cash flow.
For accounting purposes, a payee records a note receivable as an asset on its balance sheet and the related interest income on its income statement. The portion of the note receivable due to be repaid within one year is classified as a current asset and the balance as a long-term asset.
Accounts Receivable vs Notes Receivable and Accounts Payable vs Notes Payable
What is notes receivable?
Notes receivable is another line item on the balance sheet to record the amount a customer or client owes that the business has yet to receive. You record these debts as notes receivable if there is a promissory note attached to the debt. This projected income is still considered an asset as long as you expect to receive the debt within the next year.
For example, a construction company thats providing services to a building owner may communicate that the cost of the construction project will total $10,000. If the construction business wants to start work, even though the client isnt able to pay at the time, it may attach a promissory note to the contract that the client must sign that states they agree to pay the final total of the project, including accrued interest. The $10,000 total will appear under notes receivable on the balance sheet.
What is accounts receivable?
Accounts receivable is a line item, or group of line items, that appear as assets on a balance sheet. The purpose of accounts receivable is to monitor the money a customer or client owes to the business that the company has yet to receive.
For example, a company that provides paper and related products, like notepads, portfolios and pens, to a law firm may have an arrangement with the firm to deliver products without immediate payment and later send an invoice. If one order totals $500, the company would record this figure under accounts receivable because the law firm owes this money and hasnt paid it to the business. Once the business delivers the products to the law firm, itll also record the $500 as income.
Accounts receivable vs. notes receivable
Even though accounts receivable and notes receivable both appear on the balance sheet as assets and show unpaid debts that customers and clients owe to the business, there are some differences between the two statuses, including:
FAQs about accounts receivable and notes receivable
Here are some frequently asked questions with answers about these two types of line items:
What does a large accounts receivable amount indicate?
A large accounts receivable balance can be positive or negative depending on business operations and the ability of the individuals or companies that owe money to the organization to pay their debt. A large accounts receivable balance can mean that the company sells a fair amount of products and services; otherwise, the balance may not exist in the first place unless the business is a cash-only one.
Conversely, a large accounts receivable balance correlates with a higher chance that these debts will go unpaid. The more an accounts receivable ages, the more likely that a company will either need to write off the debts or convert them to a notes receivable with an attached promissory note to help support the customers ability to pay. A high accounts receivable balance can put the company at risk of losing more money than it intended and not meeting its goals.
Whats the difference between notes receivable and notes payable?
Some companies have both notes receivable and notes payable sections within their financial statements. While notes receivable is the amounts that customers owe a business, notes payable is the amount of money that a business owes to another company, usually a supplier or vendor.
What are the benefits of a customer using notes receivable?
Businesses may be open to notes receivable for customers because, if they attach interest terms to the promissory note, the organization actually receives more money than it may have otherwise. Also, notes receivable is a way for the client to acknowledge their debts and enter into an agreement with the company that ensures the organizations leadership that theyre more likely to secure the funds owed to the business.
Is notes receivable part of accounts receivable?
What is the difference between accounts receivable and notes receivable quizlet?
What is the difference between notes receivable and notes payable?
Notes Payable is a liability as it records the value a business owes in promissory notes. Notes Receivable are an asset as they record the value that a business is owed in promissory notes.
What is the main difference between accounts receivable and payables?