What it means
The difference from a term loan is control. A term loan sets a repayment schedule that both sides can plan around, whereas a demand note leaves the timing entirely with the lender, who may call the balance for any reason or for none at all.
Lenders like demand notes because they can withdraw quickly if the borrower's position weakens. Borrowers accept them because they are cheap and fast to put in place, needing far less documentation and negotiation than a committed facility.
The accounting treatment follows the legal reality rather than expectations. Because the money could be required within twelve months, a demand note is classified as a current liability no matter how long everyone assumes it will stay outstanding, which can make a balance sheet look tighter than the commercial reality feels.
Groups use demand notes to move cash between entities without arranging a formal facility, and founders use them so that money put into a business is recorded as a loan rather than as equity. In both cases the interest rate needs to be commercially reasonable, because tax authorities look closely at lending between related parties.
The practical risk is a call at the worst possible moment. Careful borrowers keep a standby facility or a cash buffer sized to the note, and some negotiate a short notice period, commonly 30 or 90 days, so that a demand does not become an immediate solvency crisis.
In practice
Real-world examples.
Example
A founder lends $80,000 to her own startup on a demand note at 6% while a funding round is being negotiated. The round closes six months later and the company repays the principal plus 80,000 x 0.06 / 2 = $2,400 of interest.
Example
A distributor operates a $500,000 working capital facility that the bank documents as repayable on demand. The facility is reviewed annually, and the bank reserves the right to call it if covenant headroom disappears.
Example
A group treasury function moves $2,000,000 from a cash-rich subsidiary to a growing one using a demand note at an arm's length rate. The structure keeps the transfer reversible and gives the auditors a clear document to point at.
Formula
Calculation
Interest = principal x annual rate x (days outstanding / 365). Payoff amount = principal + accrued interest.
A parent company advances $150,000 to a subsidiary on a demand note at 8% a year, simple interest, calculated on actual days over a 365-day year. The parent calls the note after 219 days.
Annual interest: 150,000 x 0.08 = $12,000, which works out at 12,000 / 365 = $32.88 a day.
Time outstanding: 219 / 365 = 0.6 of a year.
Interest due: 12,000 x 0.6 = $7,200.
Total payable on the call: 150,000 + 7,200 = $157,200. The subsidiary had budgeted for the note to run a full year, so it had to find $157,200 four and a half months earlier than planned.
Had the parent called the note at 90 days instead, the interest would have been 12,000 x (90 / 365) = $2,958.90 and the payoff $152,958.90, which is the point of the instrument: the amount is knowable but the date is not.Case study
Seen in the real world.
Thornbury Optics is a fictional lens manufacturer invented to illustrate how a demand note can distort a balance sheet. An investor advanced $600,000 on a demand note at 9% to fund a new coating line, and both sides privately expected the money to stay in place for three years.
The auditors classified the note as a current liability, because that is what the wording required. Current assets of $2,400,000 against current liabilities that rose from $1,500,000 to $2,100,000 pushed the current ratio from 2,400,000 / 1,500,000 = 1.6 down to 2,400,000 / 2,100,000 = 1.14, breaching a bank covenant that required 1.25.
Thornbury renegotiated the note into a three-year term loan with only $120,000 falling due within twelve months. Current liabilities became $1,620,000 and the ratio recovered to 2,400,000 / 1,620,000 = 1.48, comfortably above the covenant. Nothing about the underlying cash had changed, only the legal wording that determined how it was classified.
Watch out
Common mistakes.
- Treating a demand note as long-term funding in cash flow planning, when the lender can require repayment at any point.
- Classifying it as a non-current liability because repayment is not expected soon, which misstates the balance sheet and can mislead lenders.
- Leaving the interest rate at zero or an arbitrary number on a related party note, which invites a tax challenge and an adjustment.
Questions
People also ask.
Is a demand note the same as a promissory note?
A demand note is a type of promissory note, distinguished by having no fixed maturity date and being repayable whenever the holder asks.
Why would a borrower ever agree to one?
Because it is quick, cheap and lightly documented, and for small or related party amounts the flexibility usually outweighs the timing risk.
How should the interest be recorded?
Interest accrues over the period the money is outstanding and is expensed as it accrues, with any unpaid amount sitting as accrued interest payable alongside the principal.
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