What it means
At its most basic, a note, often called a promissory note, is a signed document in which one party, the maker, promises to pay another, the payee, a specific amount. It normally states the principal (the amount borrowed), the interest rate, the repayment dates and what happens if the borrower defaults.
Because it is a formal written promise, it can be enforced in court and often sold to someone else. Businesses use notes in many ways.
A company might borrow from a bank on a term note, a founder might lend money to the business through a shareholder note, and a supplier might accept a note from a customer who cannot pay an invoice right away. On the balance sheet the borrower records a note payable and the lender records a note receivable.
In the securities world the word has a more specific meaning. Government notes such as US Treasury notes are debt securities with maturities longer than short-term bills but shorter than long-term bonds, and corporations also issue medium-term notes.
The general rule is that notes sit in the middle of the maturity range, but the exact cut-off varies by market. Notes can be secured or unsecured.
A secured note is backed by collateral, such as equipment or property, which the lender can claim if the borrower fails to pay, while an unsecured note relies only on the borrower's promise and creditworthiness. Unsecured notes usually carry a higher interest rate to compensate the lender for the extra risk.
When reading a note, check four things: the principal, the rate, the payment schedule and the default terms. Small wording differences, such as whether interest is simple or compounded, or whether payments are due monthly or at maturity, can change the total cost substantially.
In practice
Real-world examples.
Example
A landscaping company needs a new $30,000 truck and signs a note with a local bank, secured on the truck. It repays $600 of principal plus interest each month, and the bank can repossess the truck if payments stop.
Example
A founder lends her own start-up $100,000 and records it as a shareholder note at 5% interest. The note appears as a liability on the company's balance sheet, and the interest is an expense in its income statement.
Example
A wholesaler sells $20,000 of goods to a retailer that is short of cash. Instead of waiting, the retailer signs a 90-day note for the full amount plus a small interest charge, giving the wholesaler a legally enforceable claim.
Formula
Calculation
Simple interest on a note = Principal x Annual interest rate x Time in years
Suppose a business signs a $50,000 note at 8% simple annual interest, repayable in full after 9 months. The time in years is 9 / 12 = 0.75. Interest = $50,000 x 0.08 x 0.75 = $3,000. The total repaid at maturity is $50,000 + $3,000 = $53,000.Case study
Seen in the real world.
Copperfield Bikes is a fictional retailer that wanted to open a second store but did not have enough cash. The owner approached her bank and agreed a $120,000 term note over four years, secured against the shop's stock and fittings. The bank explained that the monthly instalment would be fixed and that missing three payments in a row would put the note in default.
For the first year trading was slower than expected, and the owner was tempted to skip a payment. Her accountant pointed out that default terms in the note could allow the bank to demand the full balance at once. In this illustrative story she cut inventory purchases instead and kept every payment on time, which later helped her negotiate better terms on a second note.
Watch out
Common mistakes.
- Assuming a note and a bond are the same thing. A note is usually shorter in term and may be a private agreement, while bonds are typically longer-term securities traded in public markets.
- Ignoring the default and acceleration clauses. These can allow the lender to demand the whole balance immediately after a single missed payment.
- Recording a note as a normal expense or revenue. Principal is a balance sheet item, and only the interest flows through the income statement.
Questions
People also ask.
What is the difference between a note payable and a note receivable?
A note payable is a liability for the borrower, while a note receivable is an asset for the lender.
Is a handwritten note legally binding?
It can be if it contains the amount, the promise to pay, the parties' names and a signature, although a properly drafted document is far easier to enforce.
What is a Treasury note?
It is a government debt security with a maturity in the medium range that pays interest twice a year until it matures.
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