Not all businesses operate on a cash basis. Many businesses extend credit to their customers and clients, which means they may be owed money in the form of receivables. When a business is owed money, it’s said to have an accounts receivable balance.
Accounts receivable (A/R) represents the credit sales of a business, or money owed by customers who have purchased goods or services on credit. Credit sales are any sales made where the customer does not pay immediately but instead pays at a later date. The terms of repayment are typically outlined in the sales agreement between the two parties.
What are Notes Receivable
It can be compared with invoices receivable, which is money that a business is owed for goods or services that have already been provided. The key difference is that with notes receivable, the debt is not yet due, while invoices receivable are typically due within 30 days.
How does a Note Receivable work
The holder, or bearer, of a written promissory note, obtains the right to receive the amount stated in the legal agreement. Promissory notes are a formal commitment to pay money to someone at a specific future date.
This means that the issuer of the note must pay the holder a specified sum of money on demand, or at a specific future date. The note will also state the interest rate that will be applied to the amount owed, as well as any other terms and conditions.
The most common type of promissory note is a banknote, which is issued by a bank or other financial institution. Other types of promissory notes include bonds, IOUs, and exchanges.
Key components of a Note Receivable
There are mainly 5 key components of a note receivable. They are as follows:
- The value: The value reflects how much is owed. This will be the original amount of the purchase, plus any interest that has accrued.
- The maker: The maker is the person or company who makes the note promising to pay the holder.
- The payee: As the name suggests, the payee is the person or company who will receive payment.
- The interest rate: This is the percentage of interest that will be charged on the outstanding balance.
- The time frame: The timeframe is as simple as it sounds – it’s the length of time that the note is valid as this will be stipulated in the agreement.
Every business should keep track of the money it is owed, and notes receivable are one way to do this. This accounting item records the value of money that a business is owed, and will be paid in the future. It’s important to understand the key components of a note receivable, as well as how they work, to ensure that your business is keeping track of its receivables in the most effective way possible.
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