Notes Payable vs Accounts Payable

To help you better understand some of the key terms of accounting, we will discuss notes payable and accounts payable and how they vary.

As a small business owner, it can be difficult to determine how to handle your business's accounting aspect, especially if it is not in your area of specialization.

The differences between notes payable and accounts payable are straightforward, and it's easy to incorporate that knowledge when handling the books. In essence, notes payable are a type of loan given by the lender to the business. Accounts payable report how much money a business owes a supplier. 

In this article, we will discuss in detail the definitions of notes payable and accounts payable. We will also cover the main differences between the two terms. We will cover specific and relatable examples of notes payable and accounts payable for different businesses, so keep reading to learn more.

Differences in Notes Payable & Accounts Payable

In the accounting world, there are quite a few terms that sound similar; notes payable and accounts payable fall into that category. Since notes payable and accounts payable are distinct from each other, we will highlight their differences and break down the definitions to give you a better understanding of each term. 

The following chart highlights the main differences between notes payable and accounts payable:

This introductory information provides some of the key differences between notes payable and accounts payable, but you may need a bit more description of each of these terms. Let us now compare notes payable and accounts payable fully, reporting on both the similarities and differences. 

A Comparison of Notes Payable & Accounts Payable

As you can see, the differences between accounts payable and notes payable are pretty apparent. Let us expand on these points briefly then we will dive into complete explanations of each of these terms.

The following chart helps compare the differences between notes payable and accounts payable to make things more clear:

Now that you have a better understanding of how accounts payable and notes payable compare, it is time to define these terms in depth. Read on to learn about notes payable, accounts payable, and we will wrap up with their outright similarities.

What Are Notes Payable?

Notes payable are a type of contract between a business and a supplier. This is a written and documented agreement, sometimes referred to as a promissory note. Generally, these are a loan where interest and the amount of the loan are agreed upon before loaning the money. Additionally, there is a specific date by which all the money is due. 

The following list highlights the key parts of a notes payable:

• Collateral – The loan also denotes if any collateral can be seized if the note is not paid in full by the maturity date.
• Interest rate – Since notes payable are essentially loans, they have an interest rate associated, so as the time of purchase is farther away, the more money you will need to pay in the long run.
• Limitations – The payee has a right to add any limitations to the loan as they deem fit. The payer agrees to any limitations by signing the loan. 
• Maturity date – Date by which the entire notes payable, including interest, must be repaid.
• Owed amount – This is the amount of money a company owes a supplier
• Payee – The name of the company to which the money is owed. 
• Payer – This is the name of the company responsible for paying off the notes payable.
• Signature and date – The notes payable is signed and dated by the issuer of the note. 

Notes payable can be referred to as current liabilities or long-term liabilities, depending on the length of time in which the loan is due. If it is due in a year or less, it is recorded as a current liability. If the notes payable's maturity date is longer than a year, it is a long term liability. 

You can get a promissory note from the following sources:

• A bank
• A similar financial institution
• A vendor
• An individual  

Basically, entries on a notes payable account are all loans received from one of the above entities. They can be for any amount, have an associated interest rate and a specific due date. 

The following is a list of examples of what businesses tend to use notes payable for:

• Building materials
• Bulk purchases
• Equipment
• Facilities 
• Property

Because many businesses require loans as capital for their business, it is important to understand what you are getting into when you take out a loan. Loans are much more serious than an accounts payable account.

What happens when a notes payable is not paid on time?

• Increased interest rates in the future
• Your credit score lowers
• A poor reputation among other vendors and lenders is garnered 
• You may have trouble securing a future promissory note

Again, this is a major difference from accounts payable, which do not accrue interest, and for the most part, do not have a required or binding payment date. 

How Do You Calculate Notes Payable?

Notes payable are recorded on the balance sheet as such. They will be categorized further as either a current or long-term liability. To calculate the amount due, simply add all of the outstanding promissory notes together. 

This solution is the total amount due out of the notes payable that have not been settled. Generally, you will see the notes payable account debited on a balance sheet and the cash account credited. 

Even though notes payable are different from accounts payable, they are similar in a few ways. 

What Is Accounts Payable?

Accounts payable are the agreements created between business and supplier when the business purchases a good or service on credit. Generally, these agreements are paid off in the short term, less than a year, or within one operating cycle, whichever ends first. An accounts payable also falls into the current liabilities category. 

The following is a list of basic features of an accounts payable:

• A type of financial agreement
• Considered a current liability on the balance sheet
• Paid with credit instead of cash, the balance must be rectified after a certain number of days
• Payment terms are agreed upon by both company and supplier

An accounts payable can be as simple as an invoice or bill received that states the date on which the payment needs to be made. 

To get you more familiar with what might be considered accounts payable, here is a list of examples:

• Bill
• Sales invoice
• Services obtained on credit, like utilities or legal aid

Knowing what an accounts payable refers to is a good idea to understand how you would calculate your total accounts payable balances. 

How Do You Calculate Accounts Payable?

As described by the Corporate Finance Institute, it is important to accurately calculate the accounts payable values on your balance sheet. In order to do this calculation, you need to figure out three different numbers:

• Accounts payable days, or the average number of days it takes to repay your accounts payable
• The cost of goods sold
• The number of days in the billing or operating period

Once you have the above three values, you are ready to move on to your calculations.

You can use the following steps to calculate the accounts payable value your business has acquired:

1. Multiply. Take the number of accounts payable days by the cost of the goods your selling. 
2. Divide. Use the number calculated in step one and divide it by the number of days in the billing period. 
3. Apply. The number calculated in step two is the value associated with the accounts payable. You can now use this number on your balance sheet. 

Now that we have adequately covered the differences between notes payable and accounts payable, as well as strictly defined these terms, we will cover their similarities next. 

Similarities in Notes Payable & Accounts Payable

There are not too many similarities between notes payable and accounts payable. The main similarity is that both notes payable and accounts payable are liability accounts. Since they are both liability accounts, they are financially reported similarly, but this can vary depending on your business. 

The following is a list of similarities between notes payable and accounts payable. Notes payable and accounts payable are both:

• Liability accounts – Accounts payable are paid in the short term, and notes payable can be paid in the short or long term. 
• Reported similarly – These payables are usually reported as credits on a balance sheet, but sometimes a notes payable will appear as a debit. 
• Can be current liabilities – This is true if the requested payment is due in a year or less.

Not only are these two terms similar in name, but they are similarly reported on your balance sheet. We will next cover exactly how you can report these liabilities on your balance sheet.

How Do You Report Payables On A Balance Sheet?

Reporting notes payable and accounts payable can be a very similar process. However, reporting notes payable is a bit more complicated due to many of these credits' interest rates. 

The following are two simple steps you can use as a guide on how to report accounts payable on a balance sheet with examples:

1. Record the purchase. Debit the inventory, goods, or services you acquired on your balance sheet. Also, credit your accounts payable for the same amount.

1. Record the repayment. Debit your accounts payable account and credit cash to the total cost of the goods or services provided. 

As a complete example, for an accounts payable account, look at the following balance sheet:

As you can see from this balance sheet, the accounts payable account was credited with the received inventory's total value. Then after 15 days, a payment was made, and cash was credited to the accounts payable account. This settled the debt and rectified the amount owed. 

Use the following steps as a guide to reporting your notes payable on a balance sheet:

1. Record the purchase. Debit the inventory, goods, or services you acquired on your balance sheet. Also, credit your accounts payable for the same amount.
2. Record the interest. Enter the interest expense as a debit and enter the interest payable as a credit.
3. Record the repayment. Debit your accounts payable account and credit cash to the total cost of the goods or services provided. 

Here is an example of a balance sheet for notes payable with interest included adapted from Corporate Finance Institute:

For the above notes payable example, we used a $1,000 with a 5% interest rate for each month over the loan's 3-month term. 

As you can see from the above example balance sheet, notes payable require more entries, and you can easily see how you will be paying more in the long run for a loan with an interest rate. 

In Summary: These Payables Are Different

Notes payable are not the same as accounts payable. But because their names are similar, it can be easy to confuse them. Additionally, because they do have some similarities, you may want to consult an accountant for expert advice when it is time to balance your books.

A quick refresher: notes payable are long term promissory notes with interest and strict maturity dates, while accounts payable are short term credits for goods and services with no interest or strict date for payments to be made.

With all this information on notes payable and accounts payable, you should be more familiar with the exact definitions of the terms and how they relate to each other. As a small business, it is important knowledge to acquire, especially if you are doing the accounting yourself!