Accounts Payable Vs. Notes Payable: What’s The Difference?

In today’s dynamic business environment, understanding financial liabilities is crucial for effective management. Two of the most prevalent liability accounts in accounting are accounts payable and notes payable. While these two terms may seem interchangeable, they serve distinct purposes and are governed by different rules.

This article will clarify the differences between notes payable and accounts payable, providing real-world examples to illustrate each concept.

Key Takeaways

• Accounts payable represents a company’s short-term obligations to pay suppliers for goods and services received.

• Notes payable refers to formal agreements that document a company’s obligation to repay borrowed funds, typically from financial institutions, within a specified timeframe.

• Accounts payable is primarily used for everyday operational expenses, while notes payable is associated with larger, long-term investments like real estate and equipment.

What Is the Difference Between Notes Payable and Accounts Payable?

While both notes payable and accounts payable represent amounts owed by a company, several key differences exist:

• Written Agreements: Accounts payable typically do not involve formal contracts, relying instead on verbal agreements regarding payment terms. In contrast, notes payable are always documented through a formal contract that specifies repayment terms.

• Conversion: Accounts payable can be converted to notes payable if a company cannot meet its short-term obligations, often as a measure to avoid default. However, notes payable cannot be converted to accounts payable.

• Source of Credit: Notes payable usually originate from banks or financial institutions, whereas accounts payable arise from transactions with suppliers and vendors.

• Purchased Assets: Accounts payable typically cover routine business expenses like inventory and utilities, while notes payable often finance major capital expenditures such as property and equipment.

• Risk Assessment: Transactions under accounts payable are generally considered low-risk due to established vendor relationships, while notes payable involve higher risk and require formal agreements.

• Working Capital Calculation: Accounts payable is always considered a current liability in working capital calculations, whereas notes payable can be classified as current or long-term liabilities based on their terms.

• Liability Classification: Accounts payable are recorded as short-term liabilities, typically due within one year. Notes payable can be classified as either short-term or long-term, depending on their maturity dates.

• Additional Terms: Accounts payable usually have no specific payment terms outside of the agreed repayment period. Notes payable often include various terms such as interest rates, maturity dates, and restrictions on the borrower’s activities.

What Is Accounts Payable?

Accounts payable is a liability account that tracks a company’s short-term debt obligations to suppliers for goods and services. It often encompasses regular purchases necessary for ongoing operations, such as inventory, utilities, and other essential services.

Unlike long-term liabilities, accounts payable must be settled within a year to prevent default, and they typically do not involve fixed payment terms or interest rates.

Effective management of accounts payable is vital for maintaining a healthy cash flow. An increase in accounts payable may indicate a company is purchasing more goods on credit, whereas a decrease suggests timely debt repayment. Poor management of accounts payable can lead to liquidity issues, hindering business operations.

For each credit entry in accounts payable, the corresponding supplier recognizes the transaction in their accounts receivable.

Examples of Accounts Payable

Examples of transactions recorded under accounts payable include:

• Leases: Companies may choose to lease equipment instead of purchasing it outright. For instance, airlines often lease aircraft due to high costs.

• Licensing: Businesses may license software on credit, especially if sudden needs arise that exceed their immediate cash flow.

• Travel Expenses: Travel costs for employee attendance at conferences are often recorded under accounts payable until settled.

• Transportation and Logistics: Companies often utilize third-party logistics providers, incurring expenses that fall under accounts payable.

• Raw Materials: Manufacturers frequently acquire raw materials on credit due to the high volume and cost of production inputs.

• Subcontracted Services: Many businesses rely on subcontractors for specialized services, which are recorded in accounts payable until payment is made.

• Legal Services: Costs for legal representation are typically paid on credit and recorded under accounts payable.

• Supplier Shipments: Companies may receive goods from suppliers before payment, which are recorded as accounts payable until paid.

What Is Notes Payable?

Notes payable is a liability account that tracks a company’s commitments to repay specific amounts borrowed, typically from banks or financial institutions. These funds are usually used for significant purchases, such as property or equipment, rather than everyday operational expenses.

Notes payable are formalized through promissory notes that outline repayment terms, including maturity dates and interest rates. Companies may face restrictions on financial activities, such as paying dividends, until these notes are fully repaid.

Typically, notes are structured to be paid back within one year, but longer terms can be negotiated. When a company issues a promissory note, it records the transaction by debiting a cash account and crediting the notes payable account.

In addition to notes payable, related accounts on the balance sheet may include:

• Cash: Credited by the amount of the loan.

• Notes Payable: Debited for the loan amount.

• Interest Expense: Debited for the accrued interest.

• Interest Payable: Credited for the same interest amount.

Examples of Notes Payable

Notes payable can encompass both short-term and long-term liabilities. Short-term examples include:

• Bulk purchasing of materials or software licenses.

Longer-term notes may be issued for:

• Securing substantial loans for infrastructure projects.

Consider these two practical examples:

1. Example Notes Payable #1

   James borrows $10,000 from Erin for a store down payment. He signs a note obligating him to monthly payments of $300 plus $40 interest until the debt is settled. This transaction appears as a credit to cash and a debit to notes payable on James’ balance sheet. The monthly interest is recorded as a debit to interest payable and a credit to cash.

   Account Title	Debit	Credit
   Cash		$10,000
   Notes Payable	$10,000

   Account Title	Debit	Credit
   Cash		$40
   Interest Payable	$40

2. Example Notes Payable #2

   You borrow $25,000 from the bank for renovations, agreeing to monthly payments of $450 and a 5% interest rate ($125). Your balance sheet reflects a credit to cash for $25,000 and a corresponding debit to notes payable. The interest payable is recorded as a debit, and the cash account is credited for the interest.

   Account Title	Debit	Credit
   Cash		$25,000
   Notes Payable	$25,000

   Account Title	Debit	Credit
   Cash		$125
   Notes Payable	$125

Accounts Payable and Notes Payable FAQ

1. What is an example of notes payable?

   Examples include purchasing a building, acquiring a company vehicle, or securing a bank loan. Notes payable can be categorized as short-term (less than 1 year) or long-term (1 year or more) based on their maturity.

2. What is notes payable in a balance sheet?

   Notes payable appears under current or long-term liabilities on the balance sheet, depending on their due dates.

3. Are notes payable an expense?

   Notes payable and accounts payable are classified as liability accounts, not expenses, though accounts payable can help forecast future expenses.

4. Is notes payable debit or credit?

   Notes payable is recorded as a debit entry, with the cash account credited, signifying its liability status on the balance sheet.

5. What should a note payable include?

   A note payable should contain:

   • The amount owed
   • The interest rate
   • The maturity date
   • Name of the payer
   • Name of the payee
   • Signature of the issuer
   • Date of signing

Author

Chris Kolmar

Chris Kolmar is a co-founder of Zippia and the editor-in-chief of the Zippia career advice blog. He has hired over 50 people in his career, been hired five times, and wants to help you land your next job. His research has been featured on the New York Times, Thrillist, VOX, The Atlantic, and a host of local news. More recently, he's been quoted on USA Today, BusinessInsider, and CNBC.