Understanding Notes Receivable: Definition and Examples

Late payments are a persistent challenge for U.S. businesses, with 39% of B2B invoices paid late, slowing down revenue collection and straining cash flow. For businesses struggling with these delays, notes receivable offer a formal, legally binding solution. 

Unlike regular invoices, notes receivable provide a structured repayment plan that ensures timely payment, helping businesses stay on top of cash flow. Additionally, 91% of mid-sized businesses using automated systems for managing receivables report improved cash flow by speeding up payment cycles and reducing manual errors.

This blog will explore what notes receivable are, how they work, and why they matter to your business's financial health. We’ll also explore practical examples and key strategies for managing accounts receivable notes effectively, helping you stay on top of payments and optimize cash flow. Let’s begin. 

Key Takeaways

• Formal Agreements Matter: Notes receivable are legally binding promises to pay, making them more secure than standard accounts receivable.
• Interest and Asset Classification: They earn interest and are recorded as current or non-current assets, improving financial clarity.
• Structured Repayments: Notes provide clear repayment schedules, protecting businesses from late or missed payments.
• Accounting Accuracy: Proper recording of principal, interest, and defaults ensures accurate financial statements and reliable cash flow.
• Cash Flow Flexibility: Notes receivable can be pledged, assigned, or factored to generate immediate cash, supporting growth and operational needs.

What is Notes Receivable?

Notes receivable are formal agreements where a company lends money or extends credit to a customer through a promissory note. This document legally binds the customer to repay the debt within a set period, often with interest. 

Key aspects of notes receivable include:

• Formal Agreement: It’s a written promise to pay, adding legal weight compared to typical credit transactions.
• Asset Classification: Notes receivable are considered assets on the balance sheet because they represent money owed to the business.
• Current vs. Non-Current Assets:
  • If repayment is due within a year, the note is classified as a current asset.
  • If repayment extends beyond one year, it’s classified as a non-current asset.
• Interest Income: The company earns interest income on the amount due, which is recorded on the income statement.

Businesses often use notes receivable for larger purchases or employee cash advances. Notes receivable can be sold to third parties or used to secure financing, helping businesses manage cash flow more effectively.

Now that we've covered the basics, let's explore how notes receivable differ from regular accounts receivable.

Notes Receivable vs. Accounts Receivable

While both notes receivable and accounts receivable represent amounts owed to a business, they differ significantly in terms of structure, payment terms, and legal enforceability. Here’s a comprehensive table of the key differences:

Understanding which type of receivable applies to your business helps you manage credit and forecast cash flow with greater accuracy.

With that distinction in mind, let’s take a closer look at the key components that make up a notes receivable.

Key Components of Notes Receivable

Notes receivable are formal agreements to ensure timely payments, often including both a repayment plan and interest. Here’s a breakdown of the key elements:

• Payee: The payee is the entity holding the promissory note, entitled to receive the principal amount along with any interest. This is usually a business or financial institution, and the note is recorded as an asset, representing future cash inflows.
• Maker: The maker is the borrower responsible for repaying the note. This could be either an individual or a business, and they must adhere to the repayment terms outlined in the promissory note.
• Principal: The principal is the original loan amount that the maker must repay by the maturity date. This forms the basis for calculating any additional costs, such as interest.
• Maturity Date: This is the agreed-upon date by which the maker must repay the full amount. Depending on the term, notes receivable may be classified as either current or non-current assets on the balance sheet.
• Interest: Interest is the extra cost the maker pays for borrowing the principal amount. This is a key component that distinguishes notes receivable from accounts receivable, offering compensation for the extended payment terms.
• Interest Rate: The interest rate is the percentage applied to the principal to determine the total interest owed. It’s vital for both parties, as it directly impacts the cost of borrowing and the return for the payee.

These components make notes receivable a more secure and structured financial resource than standard accounts receivable. 

VJM Global simplifies the management of notes receivable by providing accurate, outsourced accounting services. We ensure proper classification, timely interest tracking, and full compliance, so you can focus on growing your business. Get in touch today.

Understanding these components sets the stage for creating a proper note. Here’s a simple template you can use.

Template of a Note Receivable

For businesses that accept promissory notes as a form of payment, having a clear, standardized template is essential. Below is a template that can help you create a legally binding note for your transactions:

[Principal value]

[City, Province or Territory, Agreement date]

For value received, the undersigned, [Name of maker], agrees to pay to [Name of Payee], the principal sum of [Principal value], with interest at the rate of [Interest rate]% per annum on the outstanding balance. The interest will accrue from the date of this agreement until the principal is paid in full.

The principal amount and interest are payable in lawful currency of the United States at [City and Province or Territory], as specified by written notice from the holder of the note to the maker, on the specified date. The payment terms are as follows:

Upon demand, not later than [term length]

[Address of maker]

[Signature of maker]

[Seal of the maker]

[Signature of payee]

[Seal of payee or company]

This template provides a foundation for creating a formal note receivable that both the business and customer can rely on. 

Also Read: Comprehensive Guide to Accounts Receivable Journal Entries

Now that you have the template, let's walk through some real-world examples to see how notes receivable are used.

Examples of Notes Receivable

Notes receivable are commonly used when businesses formalize an agreement for repayment with specific terms. Here are three examples highlighting different scenarios:

1. Restaurant Equipment Purchase 

If a restaurant purchases $25,000 of new equipment on credit from a supply store, the supplier normally expects payment within 60 days. 

Since the restaurant is newly opened and struggling with cash flow, it requests an extension. The supplier agrees and issues a one-year promissory note at an interest rate of 8%.

Journal Entry at Issuance:

Journal Entry at Payment (Maturity):

*Interest = $25,000 × 8% = $2,000 over one year.

Hence, a standard invoice can be replaced with a promissory note, giving the restaurant more time to pay while securing the supplier’s right to collect interest.

2. Trade Credit

A customer buys $10,000 worth of goods on credit and issues a 90-day promissory note with 5% annual interest. This shifts the transaction from accounts receivable to notes receivable.

Journal Entry at Issuance:

Journal Entry at Payment (Maturity):

The above example is one of the most common uses of notes receivable: converting a credit sale into a legally binding repayment with interest.

3. Loans to Employees or Third Parties

A company lends $5,000 to an employee, formalized by a 1-year note at 6% interest.

Journal Entry at Issuance:

Journal Entry at Payment (Maturity):

Hence, notes receivable can also arise from internal loans, not just customer transactions.

4. Advance Payments

A business makes an advance payment of $3,000 to a vendor, secured with a promissory note to guarantee repayment.

Journal Entry at Issuance:

Journal Entry at Repayment:

Businesses can thus use notes receivable to protect advance payments made to vendors.

5. Installment Agreements

A customer purchases equipment worth $12,000 but prefers to pay in monthly installments with interest. The arrangement is recorded as notes receivable.

Journal Entry at Issuance:

Journal Entry at First Installment:

The above example is a case of structured repayment, where the business receives both principal and interest over time instead of a single lump sum.

These examples show how notes receivable formalize transactions and provide structured repayment plans for various situations, from trade credit to employee loans. 

Struggling to manage complex notes receivable and maintain cash flow? VJM Global’s expert accounting services help streamline the process, ensuring accurate record-keeping and efficient repayment tracking, so your business can focus on growth and success. 

Next, let’s explore how to record and manage these notes in your accounting system.

Accounting for Notes Receivable

Recording notes receivable ensures businesses track amounts owed and classify them as assets on financial statements. These formal agreements define structured repayment schedules.

Initial Recording of Notes Receivable

• Debit Notes Receivable when the note is issued.
• Credit Sales, Cash, or Accounts Receivable, depending on the transaction source.
• Interest is not recorded until it is earned.

Interest Accrual

• Record interest at the end of the accounting period or at maturity.
• Debit Interest Receivable, credit Interest Income to reflect earned interest.

Receipt of Payment

• Debit Cash for the total received.
• Credit Notes Receivable for the principal.
• Credit Interest Income for accrued interest.

Defaulted Notes Receivable

• Transfer unpaid notes to Accounts Receivable if the borrower defaults on payment.
• Include principal and unpaid interest in the transfer.
• Use the allowance account if the debt later proves uncollectible.

Classification and Valuation

• Record notes at face value.
• Add accrued interest as Interest Receivable.
• Classify as Current Asset if due within one year, Non-Current Asset if due later.
• Present on the balance sheet at Net Realizable Value (NRV), adjusted for potential uncollectibles.

Impairment and Write-Off

• If repayment appears doubtful, measure impairment as the difference between carrying value and expected cash flows.
• Debit Bad Debt Expense, credit Allowance for Notes Receivable.
• Confirmed uncollectible notes are written off: debit Allowance, credit Notes Receivable.

Using Notes Receivable to Generate Cash

• Notes receivable can be pledged, assigned, or factored to raise immediate cash.
• Useful for businesses with limited financing options.

Accurate accounting for notes receivable ensures that your financial statements reflect your true assets, supports effective cash flow management, and safeguards against potential credit losses.

Also Read: Accounts Receivable Management Best Practices Guide

Finally, let’s explore how VJM Global can help simplify the entire process, ensuring your notes receivable are well-managed.

Manage Notes Receivable Efficiently with VJM Global

Tracking and accounting for notes receivable can be time-consuming. VJM Global helps businesses simplify this process, ensuring accuracy, compliance, and better cash flow management. Key benefits include:

• Centralized Notes Management: Record all notes receivable in one place, including principal, interest, and maturity dates.
• Streamlined Accounting Entries: Rely on our outsourced accounting services to help manage journal entries for note issuance, interest accrual, payments, and defaults.
• Interest Tracking: Accurately calculate and log interest income for short-term or long-term notes.
• Default Monitoring: Identify overdue or defaulted notes quickly and update accounts receivable accordingly.
• Asset Classification: Easily classify notes as current or non-current assets for accurate balance sheets.
• Cash Flow Insights: Monitor how notes receivable impact liquidity and working capital.
• Seamless Integration: Sync with existing accounting or ERP systems for consistent financial reporting.

Ensure your notes receivable are recorded accurately and your cash flow remains predictable with VJM Global.

Conclusion

Notes receivable serve as formal agreements that secure repayment and provide businesses with predictable cash flow. Proper recording, interest tracking, and classification ensure accurate financial statements and reduce the risk of uncollectible debts. 

Handling defaults, impairments, and write-offs systematically protects both revenue and asset integrity. Using notes receivable strategically can also generate immediate cash through pledging, factoring, or assignment, supporting operational needs and growth.

Take control of your receivables and streamline your accounting process with VJM Global’s solutions, designed to simplify notes management and strengthen cash flow reliability. Contact us today.

FAQs

1. What are notes receivable?

Notes receivable are formal promises from a customer to pay you a specific amount, usually with interest, by a certain date. They’re a step up from regular invoices.

2. How do I record a note receivable in my accounting records?

When you receive a note, you debit the Notes Receivable account and credit either Sales, Cash, or Accounts Receivable, depending on the transaction. This tracks what’s owed.

3. What is the journal entry for interest on a note receivable?

You record earned interest by debiting Interest Receivable and crediting Interest Income. This shows the interest you’ve earned but haven’t collected yet.

4. How do I calculate interest on a note receivable?

Interest is usually calculated as Principal × Rate × Time. Make sure the time period matches the note’s term, like months or years.

5. What is the maturity date of a note receivable?

The maturity date is the day the full principal and any interest must be paid. It marks the end of the note’s term.

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