What it means
A note is more formal than an ordinary invoice or an IOU. It states the amount borrowed, called the principal, the interest rate, the due date and who is to be paid.
Because it is a signed document, it gives the lender stronger legal footing if the borrower does not pay. A short-term note has a maturity of twelve months or less, and many run for 30, 60 or 90 days.
A business might sign one with its bank to fund a seasonal inventory build, or issue one to a supplier in exchange for goods when it cannot pay cash. On the lender's side, a company can accept a note from a customer in place of an overdue account.
Interest on a note is normally simple, which means it is worked out only on the principal and is not compounded. It is calculated from the principal, the annual rate and the fraction of a year.
Some notes are discounted instead, meaning the lender deducts the interest in advance and hands over less than the face amount. In the accounts, the borrower records a note payable under current liabilities and accrues interest as it builds up over time.
The lender records a note receivable under current assets and recognises interest income. When the note is paid, both sides remove the balances and the interest is settled.
If the borrower cannot pay at maturity, the parties may agree to renew the note, which usually means paying the interest due and signing a new one. Repeated renewals are a warning sign to lenders.
They suggest that the borrower is short of cash. A note can also be sold or pledged before it matures.
A lender that needs cash sooner may sell the note to a bank at a discount, receiving slightly less than the maturity value in exchange for immediate funds. This is common in trade finance, where the quality of the borrower decides how much of a discount the buyer asks for.
In practice
Real-world examples.
Example
A garden centre buys $60,000 of plants and equipment for the spring season and signs a 90-day note with the supplier at 8%. It sells the stock over the next two months and pays the note from the proceeds. The supplier records the interest as income.
Example
A building contractor has a customer who is 60 days overdue on a $25,000 invoice. The contractor agrees to convert the debt to a 120-day note with interest, which gives it a formal claim. The invoice is replaced by a note receivable on its books.
Example
A small manufacturer borrows $150,000 from its bank on a six-month note to buy raw materials for a large order. When the customer pays, the manufacturer repays the bank in full. The bank holds the signed note as proof of the loan.
Formula
Calculation
Interest = principal x annual interest rate x (days / 360)
Maturity value = principal + interest
Suppose a company signs a 180-day note for $100,000 at an annual interest rate of 6%, using a 360-day year. The interest is 100,000 x 0.06 x (180 / 360) = 6,000 x 0.5 = $3,000. The maturity value is 100,000 + 3,000 = $103,000, which is the amount the company must pay on the due date.Case study
Seen in the real world.
Fernbank Bakery Supplies is an illustrative, fictional wholesaler that sold $48,000 of ingredients to a restaurant group on 30-day terms. The restaurant group was slow to pay, and by the end of the second month the invoice was still unpaid.
The credit controller proposed turning the debt into a 90-day note at 9% annual interest. The restaurant group agreed, and the wholesaler gained a signed document and extra income of 48,000 x 0.09 x (90 / 360) = $1,080.
The note was paid in full on its due date, and the wholesaler kept the customer, who went on to place larger orders with the stronger payment record behind them. The illustrative lesson is that a note can turn an awkward overdue invoice into a clear, interest-bearing obligation that both sides understand.
Watch out
Common mistakes.
- Calculating interest on a full year when the note runs for only a fraction of a year.
- Forgetting to accrue interest at the end of a reporting period, so that profit and liabilities are misstated.
- Treating repeated renewals as normal, when they may signal that the borrower cannot repay.
Questions
People also ask.
What is the difference between a note and an invoice?
An invoice is a bill for goods or services, while a note is a signed promise to repay a specific amount with interest by a set date.
Is a short-term note a current liability?
Yes, for the borrower it is a current liability, and for the lender it is a current asset, because it is due within a year.
Which day-count convention should be used?
It depends on the agreement, and 360 days and 365 days are both common, so always use the one written in the contract.
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