Account Payable vs Note Payable (Promissory Notes)
Companies and individuals may not always possess the funds or resources to carry out business operations. In such instances, it is common practice to obtain a form of credit from banks, suppliers, and other lenders in order to fill up the necessary gap in funding. These funds obtained are referred to as payables, which can be divided into accounts payable and notes payable. The following article presents an explanation of the two forms of credit along with examples to highlight the differences between the two.
What is Account Payable?
An Account payable is an amount, which is recorded in a company’s balance sheet under current liabilities, and represents an amount of money that is owed by the company and must be repaid to the creditor for the purchase of goods and services on credit. The funds that are to be repaid are usually current liabilities, as the creditor will expect these funds to be repaid within a very short period. Most suppliers allow their customers a credit period not exceeding 30 days. An example to accounts payable is as follows. Mr. Anderson purchases 500 units of rubber sheets for his shoe production business, at a total cost of $1000. He is supposed to repay his supplier within 30 days; therefore, the amount of $1000 is a current liability and will be recorded in his balance sheet under current liabilities. Once the amount is paid to the supplier, Mr. Anderson’s cash account will be credited, and his accounts payable account will be debited cancelling the credit entry, thereby closing his accounts payable account.
What is Note Payable (Promissory Notes)?
A note payable is a note that is written by a supplier representing a promise to repay funds for goods or services obtained. Notes payable are also referred as promissory notes, are usually issued by banks and other financial institutions, and are used by companies or individuals who do not have adequate funds to meet their funding needs. A note payable maybe of long-term or short-term, and it depends on the requirements of the borrower. As an example, Mr. Anderson may take the option of obtaining the required funds from a credit institution. Since he plans to repay the funds in 30 days, this will be recorded as a short-term liability in his balance sheet. He will also post a credit to the notes payable account and will debit the account once the payment has been made to the credit institution.
Account Payable vs Note Payable
There are many similarities between the two as they are both forms of credit and are recorded in the company balance sheet as a liability. Instances in which a note payable is issued by a credit institution, an agreement is signed between the two parties, to ensure that the borrower will repay. Similarly, such an agreement may also be signed between a creditor and a debtor when the creditor delays his repayment. The main difference between these two forms of credit is the period for which they are issued. Accounts payable is usually a short term credit for a few months while notes payable are usually for longer periods, minimum being 6 months. Furthermore, since notes-payable is issued by the bank, interest and repayment is set according to the contract, whereas accounts-payable is usually an informal promise to repay made based on the good faith that the two parties share.
In a nutshell:
What is the difference between Account Payable and Note Payable?
• Companies and individuals may not always possess the funds or resources to carry out business operations, in which case, they may obtain one of the two forms of credit; accounts payable or notes payable.
• The main difference between these two forms of credit is the period for which they are issued. Accounts payable is usually a short-term credit for a few months while notes payable are usually for longer periods, minimum being 6 months.
• Notes payable usually involve a written contract binding the two parties by law, whereas an accounts payable is a result of credit offered by the debtor to the borrower based on trust and good faith.