What are notes payable?
Formal loan balances owed to a bank or other lender. The line is remaining principal, not the interest.
Definition
Notes payable are the remaining principal on signed loans from a bank or other lender. On the books, this is a long-term liability, not a vendor bill and not the interest on the loan.
You record the note so the Balance Sheet shows the remaining principal. The next twelve months of that principal are often split into Current Portion Of Long-Term Debt.
Cash-basis books still show the cash that arrived when you borrowed. Accrual books also keep the owe until each Principal Payment brings the balance down.
This line is the formal loan, not a revolving draw. A signed note, a rate, and a payoff date sit behind the number.
Where it shows up
Balance Sheet: Located with the longer-term amounts owed, below current liabilities.
P&L: Related to interest on the loan.
Cash flow: Increases in this account, reported cash from financing activities increases.
See also: Long-Term Liabilities · Loan Amortization Schedule · Debt Schedule
When you look at your Balance Sheet, this line sits with the longer-term amounts owed, below current liabilities. The total is remaining principal on signed notes, after the current slice has been split out.
When the balance is high, the crew has more formal loan principal still outstanding. When the balance is low, notes have been paid down, or the shop has not borrowed this way.
The profit and loss statement does not list this account as a line. Interest on the loan hits the Income Statement; principal does not.
On the Statement of Cash Flows, borrowing on the note is a financing inflow. This account rises, and reported cash from financing activities rises with it.
A Debt Schedule lists each note, rate, payment, and maturity. A Loan Amortization Schedule then splits those payments into principal and interest.
How it works
The owe gets onto the books when you sign the note and take the funds, or when the lender pays a vendor for an asset. You debit cash or the asset and credit this account.
That entry does not wait for the first payment. The full principal is the liability from day one.
A typical note has a rate, a payment date, and a maturity. The amortization schedule tells you how much of each payment is principal and how much is interest.
Interest expense hits the P&L each period. A Principal Payment is the only piece that reduces this balance.
The current slice of principal due in the next twelve months is moved to Current Portion Of Long-Term Debt. The leftover stays here with the longer-term amounts owed.
When you make a payment, you debit this account for the principal slice and credit cash. Interest is a separate debit to expense, or a clearing of interest already accrued.
Reconcile the ledger to the lender statement, the debt schedule, and the amortization schedule. A payment posted only to expense will leave this liability too high after principal has been paid.
Covenants in the note can require a minimum coverage ratio or a clean borrowing-base report. Those terms sit in the agreement; they do not change the fact that this line is the remaining principal.
Example
A landscaping crew borrows $12,000 on a signed note to buy a used truck. The bank sends the $12,000 to the dealer on the same day.
The crew records:
Debit: Truck $12,000
Credit: Notes payable $12,000
The truck (an asset) and this liability both go up by $12,000. Cash at the shop does not move, because the lender paid the dealer.
The Balance Sheet now holds the $12,000 owe with the longer-term amounts, below current liabilities. The Income Statement does not show a $12,000 expense.
Each monthly payment later splits into interest and a Principal Payment. Only the principal slice brings this account down.
Common mix-ups
Notes payable are not accounts payable. AP is unpaid vendor bills; this line is a formal loan with a signed note.
This account is not a Line Of Credit. A line is revolving, so you can draw and repay as needs change; a note is a set loan balance with a payoff path.
This account is not the interest. Interest hits the P&L; this line is only the remaining principal on the Balance Sheet.
Related terms
- Long-Term Liabilities: Obligations that come due more than a year out.
- Current Portion Of Long-Term Debt: The slice of loan principal due within the next twelve months.
- Loan Amortization Schedule: The payment-by-payment breakdown of a loan into principal and interest.
- Principal Payment: The portion of a loan payment that reduces the balance owed.
- Interest Expense: The cost of borrowing recorded for the period.
- Debt Schedule: A supporting schedule tracking each loan's balance, payments, rate, and maturity.
- Covenant: A condition in a loan agreement the borrower must keep meeting.
- Cash Flow From Financing: Cash from borrowing, repayment, owner contributions, and distributions.