Notes receivable: Overview, definition, and example
What are notes receivable?
Notes receivable are written promises from a borrower to pay a certain amount of money to the lender at a specified future date, often with interest. It is a formal, legally binding document that represents an amount owed to the creditor (lender) by the debtor (borrower). Notes receivable are classified as assets for the lender, as they represent money that is expected to be received in the future. These notes are commonly used in business transactions, loans, or sales agreements, where payments are made over time rather than upfront.
For example, a company may issue a note receivable to a customer who purchases goods on credit, promising to pay the outstanding balance in installments over several months.
Why are notes receivable important?
Notes receivable are important because they provide a clear, enforceable record of a debt owed, including terms such as repayment schedules, interest rates, and maturity dates. They are valuable for businesses because they represent future cash inflows, which can be tracked and used in financial planning. In addition, notes receivable are often easier to collect than informal agreements, as they are legally binding documents.
For businesses, managing notes receivable is crucial for ensuring timely payments and maintaining healthy cash flow. Additionally, they can be used as collateral for further borrowing or financing needs.
Understanding notes receivable through an example
Imagine a business sells office equipment to a customer but allows the customer to pay over the course of a year. The business issues a note receivable, which outlines the terms of repayment—monthly installments of $500 plus an interest rate of 5% annually. The note specifies that the total amount due at the end of the year will be the principal plus interest. The business can track this note receivable as an asset, knowing that it will receive payments over the coming year.
In another example, a company loans money to an employee, and in exchange, the employee signs a note receivable committing to repay the loan with interest over five years. The company records this note as an asset in its financial statements.
An example of a notes receivable clause
Here’s how a clause related to notes receivable might appear in a contract or agreement:
“The Buyer agrees to pay the outstanding balance of $10,000 in 12 monthly installments, with interest at an annual rate of 6%, as outlined in the attached Note Receivable. The Note Receivable shall be due in full on [insert date], and failure to comply with the payment terms will result in legal action for recovery.”
Conclusion
Notes receivable are essential financial instruments that provide a formal, legally binding promise of future payments, making them a key component of a business's cash flow and asset management. Whether used in sales transactions, loans, or financing agreements, notes receivable ensure clarity and enforceability in debt agreements. By properly managing notes receivable, businesses can improve financial planning, track debts owed to them, and maintain steady cash inflows.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.