Accounts Payable vs Notes Payable: What’s the difference?

Accounts Payable vs Notes Payable: What’s the difference?

Accounts Payable

Accounts payable is an account on the general ledger that is mostly used to record the purchasing of goods and services on credit. It is a liability account the normally has a credit balance. The accounts payable account is mainly used to record the purchasing of goods and services so it has relevance in trees to show the incoming goods and payments to creditors. The double entry for noting accounts payable is that the accounts payable is credited while their respective account is debited. When an amount is settled for a creditor, the accounts payable account is debited while cash is credited.

The majority of accounts payable has to be settled within 12 months and is recorded as a current liability in the balance sheet. It’s crucial to manage accounts payable carefully because they impact an organization’s cast position, credit rating, and overall relationship with vendors or creditors.

In the event an organization is running out of cash and faces difficulty in making it short-term payments, its creditors may ask the company to accept a promissory note for the outstanding balance payable at a certain future date. If the terms and conditions of the note are agreed upon between the company and the Creditor, the note is written, signed, and issued to the creditor.

That arrangement converts an account payable into a note payable. Journalizing a transaction means that the accounts payable account is debited and the notes payable account is credited. Using this approach, the organization gets a Time relaxation for making a cash payment while the creditor earns an interest income on the outstanding balance until a cash payment is made against the issued note.

Notes Payable

Notes payable is a liability account that is maintained in an organization’s general ledger. It is a written promise to pay a specific amount of money within a certain time period. When a company does not have cash, it may issue a promissory note to a bank, vendor, or other financial institution to borrow the funds or acquire assets.

In the case of a promissory note arrangement, the borrower makes the note and makes an unconditional promise to pay either an individual, a vendor, or financial institution who has lent money or from whom an asset has been acquired. In the promissory note, the borrower promises a certain amount of principal money plus any interest thereon at a certain date specified in the future.

A promissory note generally specifies the interest rate, maturity date, collateral, and any limitations imposed by the creditor or the lender. These limitations may include restrictive covenants such as not paying dividends unless the promissory note has been settled.

The notes payable account in the general ledger keeps a record of all the promissory notes a company issues to lenders of funds or vendors of assets. Because the notes payable is a liability account, the normal course of entry is crediting notes payable, and debiting cash or another asset received against it. On the maturity date, the organization has to pay the principal amount plus the interest at the rate mentioned in the note. The payment is recorded by debiting notes payable account, interest account, and then crediting the cash account.

The balance in the notes payable account represents the total amount that still needs to be paid against all promissory notes the company has issued. In the majority of circumstances, promissory notes are made payable in a year’s time and the balance of notes payable is there for a reported as a current liability in the balance sheet.

Handling notes payable well means making a commitment to the payments that are supposed to be made on maturity dates. If an organization fails to abide by the promise terms and conditions, it not only leads to a bad reputation but may adversely impact its overall credit score.

If an organization has issued several notes to different parties, it’s also possible to maintain a notes payable subsidiary ledger that keeps a separate record of each note issued by it.

The Differences Between Notes Payable and Accounts Payable

Notes payable can be short-term or long-term obligations for the business. Accounts payable, are always considered short-term liabilities that must be settled within one year.

Notes payable are typically not converted into accounts payable but accounts payable can be converted into the notes payable as long as there is mutual consent and understanding of all parties involved.

Notes payable are written agreements mostly created and issued for debt arrangements and are payable to credit companies and financial institutions. Accounts payable are generally the suppliers of services and inventory.

Generally, accounts payable do not require a written document or note to specify the terms and conditions. However, an invoice issued by the seller is attached to each order. Notes payable, on the other hand, have specific terms and conditions that pertain to the debt repayment which may include interest rates, maturity date, collateral information, etc..

Accounts payable account is used to maintain the purchase of goods and services while notes payable accounts are used to record incoming and outgoing transactions from financial institutions.

Accounts payable, most often, it is a verbal understanding between both parties and there is no Associated Finance cost though there may be available trade discounts. Notes payable do have an interest component so there is a financing element involved, and the interest expense is usually considered separate of the loaned amount.

Accounts payable is always used in working capital management and has an impact on an organization’s cash conversion cycle. Notes payable, however may or may not be included as part of a company’s cash flow management.

Both notes payable and accounts payable are considered current liabilities but both accounts differ in several ways. Both liabilities have a relative impact on an organization’s overall liquidity and as such need to be managed both responsibly and efficiently.

It is within an organization’s best interest to keep the overall cash conversion cycle in check and ensure that all liabilities are honored per their commitment. This is necessary for maintaining a good reputation in your industry and will prevent you from damaging your credit score which could be highly detrimental for lenders and suppliers if you want to receive credit in the near future.