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Accounts Payable vs Notes Payable: How They Compare

Accounts Payable vs Notes Payable: How They Compare
Susan Guillory
Susan GuilloryUpdated November 10, 2022
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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 receivable, 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.

What Is 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. Recommended: Accounts Payable vs Receivable: How They Compare 

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 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.

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. 

What Is 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 many types of small business loans. It also includes promissory notes, which are similar to loan agreements. Like loan contracts, promissory notes are legally binding and provide a detailed rundown of the details of the loan. Unlike a loan contract, a promissory note won’t define how any defaults or breaches of loan terms (like late or missing payments) will be addressed.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.Recommended: How to Apply for Small business Loans 

How Does Notes Payable Work?

Notes payable involve the payment of money owed to a financial institution or other creditors. If your company borrows money under a note payable, you would debit your cash account for the amount of cash received and credit your notes payable account for the liability. When you repay the loan, you would then debit your notes payable account and credit your cash account. For the interest that accrues, you will need to record the amount 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

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.

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.

3 Small Business Loan Tips

  1. Generally, it can be easier for entrepreneurs starting out to qualify for a loan from an online lender than from a traditional lender. Lantern by SoFi’s single application makes it easy to find and compare small business loan offers from multiple lenders.
  2. If you are launching a new business or your business is young, lenders will consider your personal credit score. Eventually, though, you’ll want to establish your business credit.
  3. If you need to borrow money to cover seasonal cash flow fluctuations, a business line of credit, rather than a term loan, provides the flexibility you likely need.

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Frequently Asked Questions

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About the Author

Susan Guillory

Susan Guillory

Susan Guillory is the president of Egg Marketing, a content marketing firm based in San Diego. She’s written several business books, and has been published on sites including Forbes, AllBusiness, and Cision. She enjoys writing about business and personal credit, financial strategies, loans, and credit cards. Follow her on Twitter @eggmarketing.
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