Why Companies Should Use Notes Receivable (With Template)
By Indeed Editorial Team
Published July 7, 2021
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Notes receivable offer a company a method of collecting debts from a customer. The notes receivable is a binding agreement that provides all the terms of payment when it is first agreed. Using notes receivable can diversify your options when selling products or providing services. In this article, we discuss what notes receivable are, why companies use them and provide a template and example note for additional guidance.
What are notes receivable?
Notes receivable, also known as promissory notes, are agreements between two parties that represent a debt. A note includes the amount of the debt, the interest rate applied to the debt and the date by which the payee requires the payer to make their final payment. A note receivable is a legally binding document, with the maker obligated to pay the full balance plus interest by the agreed date. However, the maker may pay off the debt sooner if desired.
Related: What Is a Purchase Order?
Why do companies use notes receivable?
Notes receivable are an alternate option to accounts receivable when agreeing to provide products or services to a client without immediate payment. Notes receivable provide many benefits to a company owed compensation that can make them the preferable option. The most beneficial reasons to use promissory notes include:
Written agreement: A note receivable arrangement includes a written document that clearly states all terms for repayment. This removes uncertainty and provides an enforceable claim to the payment owed by the maker of the promissory note, which provides security for the recipient of the note.
Interest accumulation: When creating a note receivable, a maker and payee agree to an interest rate. This allows the payee to receive additional compensation to reimburse for not receiving payment at the time of the agreement. This offers financial incentives that accounts receivable may not include.
Resalable assets: Because a note receivable provides a legally binding agreement, it possesses value equivalent to the agreed-upon amount and any accumulated interest. This makes the note receivable a sellable asset that the payee can sell to generate cash if needed, making it a more flexible method of receiving payment.
Convertibility: If a maker is unable or unwilling to meet their obligations according to the note receivable, the payee has the option to convert it into an accounts receivable entry in their books for any outstanding balance at the end of the term. This maintains the payee's ability to seek additional remedies associated with unpaid accounts receivable if necessary.
Key notes receivable terms
When issuing a note receivable to a client, it's important to understand the most common terms used to describe elements of the agreement and how you account for it in your records. Key terms to understand about notes receivable include:
Maker: The maker of a note receivable is the person or company issuing the note. When you establish a contract with a client who agrees to pay you according to the terms of the note receivable, they are the maker of the note.
Payee: The payee is the person or company owed compensation with the promissory note. If you have a contract with a client, you are the payee on the note receivable.
Principal: The principal amount for a note receivable is the amount owed by the maker to the payee at the start of the term. Most often this will be directly equivalent to the amount owed at the time you agree to take a note receivable in place of payment.
Term: When agreeing to a promissory note, both parties agree to a date by which the maker will pay off the balance of the debt. This period is known as the term, and while the maker may opt to pay early without penalty, they must pay in full at the end of the term.
Interest: It is standard for a note receivable to include interest accrued for the duration of the term to compensate the payee for not receiving payment upfront. The payee and maker agree to an interest rate at the start of the term and interest accrues based on the outstanding balance over the term, with early payments reducing interest accumulation.
Assets: A note receivable is an asset that the payee accounts for in their records. Its classification depends on the remaining time on the term. A note receivable due within a year is a classified as a current asset, while those with a term with over one year remaining are non-current assets.
Note receivable template
If your business will accept notes receivable in exchange for goods or services, it can be beneficial to create a template for your notes. This allows you to create a new note quickly when needed by filling in the blanks with the appropriate information. This template can allow you to generate notes receivable efficiently:
[Principal amount owed]
[Location and date of agreement]
[Name of maker] promises to pay to [Name of payee] the principal amount along with interest calculated at an annual rate of [interest rate]. The payment will be completed no later than [term length] after the signed date.
[Signature of maker]
[Signature of payee]
Notes receivable example
Here's an example of a note receivable using the template above:
A home owner decides they want to remodel their kitchen and hires a private contractor to provide services as part of the remodel. The contractor agrees to a fee of $3,000 for their portion of the construction. The home owner requests a deferred payment option and they agree to a note receivable with a three-month term and 5% interest rate. The home owner intends to pay $1,000 per month, with the third payment including any interest accrued. They create the following promissory note:
Location: Byram, NJ
Date: June 3, 2021
Christopher Shelton promises to pay to Johnson Kitchen Company the principal amount of $3,000, as well as interest calculated at an annual rate of 5%. The payment will be completed no later than September 3, 2021.
Signature of maker:
Signature of payee:
Kenny Smith, Johnson Kitchen Company CEO
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