Knowing the difference between accounts payable And notes payable could be the game-changer for your business. Beyond knowing the difference between these two concepts, knowing how to put that knowledge into work will have a positive impact on your business.
Cash they say is king in every business. If this saying is true, it also means that credit is the engine room. To effectively manage your accounts payable, you need to have a stable performance as well as a high level of efficiency in operation. Notes payable on the other hand will open your business to massive growth and increased profits.
Why it Is vital to Know the Difference between Accounts Payable and Notes Payable
Many businesses mix up these two concepts thinking they are the same. However, in actuality, accounts payable is different from notes payable in many ways. While accounts payable leans more towards monthly, weekly, and daily business operations, notes payable is broader in its coverage.
With the data provided by a notes payable account, businesses can effectively plan their operations on a long-term basis. Better planning will most definitely result in higher efficiency and increased profit. When you can differentiate between these two concepts and can develop a strategy with what you know, your business will surely thrive even amid stiff competition.
How Account Payable and Notes Payable Work
Though account Payable and Notes stable are both liabilities to a business, these debts fall into distinct groups. Account payable (AP) appears in the ledger as short-term debts that the business is expected to pay off within 30 days.
Suppliers would naturally assume that the business would offset the payment within the agreed period. Vendors do not, therefore, require collateral for accounts payable. All a business has to do is to ensure it meets up the payment deadline. Once that is done, the business will continue to enjoy credit supplies from Vendors.
Notes Payable (NP), are long-term liabilities having a maturity date that is sometimes one year and above. Notes Payable will most likely involve a written agreement between the business and the supplier. This agreement will clearly state the repayment date and the penalty for default. Payable liability is likely to have collateral security attached to it.
It is worthy of note that NP also has an interest rate with a specified repayment date. The borrower is therefore aware of the time of repaying the debt and the specific amount to be paid back to the lender.
Differences between Account Payable and Notes Payable
Accounts Payable and Notes Payable differ in so many ways. Some of the differences between the two accounts are outlined below:
#1. Short-term Obligation Vs and Long-term Liabilities.
Account Payable is short-term liabilities. They refer to the amount of obligation a business owes its Vendors for supplying goods or services on credit. This short-term liability is usually cleared within 30-90 days.
Accounts Payable are recorded as current Liabilities in the company’s balance sheet. Account Payable can serve as useful data in determining the purchase mode of a business. An increase in accounts payable invariably implies that the business is making more credit purchases and vice versa.
Notes Payable, however, is long-term in nature. It involves the business borrowing money with a written promise to repay the principal and the accumulated interest at an agreed date. The total amount due to be repaid is recorded as a long-term liability in the company’s balance sheet as these loans. Notes payable are referred to as long-term loans because they are expected to be repaid in 12 months or more.
#2. Terms of agreement
The terms of the agreement are another area where account payable and notes payable differ from each other. Accounts Payable most times do not require specific terms and obligations to be entered by the parties.
Notes Payable however requires the parties to have a written agreement where the terms of the loan are spelled out. Some of the things that are captured in the agreement include the lifespan of the debt, interest rate, penalty for defaulting in repaying the loan, and collateral security. These agreements are however reached on a mutual basis.
#3. The level of risk
The level of risk involved in accounts payable and notes payable differ on several grounds. Accounts payable is a low-risk credit. Businesses with a good credit record can enjoy credit extensions from their suppliers.
The reason for this extension could be that they have over time-built integrity by meeting with payment schedules. On the other hand, notes payable involve greater risk. Little wonder the terms are spelled out to prevent payment default on the part of the borrower.
#4. Possibility of conversion
An account payable can be converted to a note payable if a business fails to pay within the agreed time. The Vendor may then come up with a written agreement to include a specific payment date, interest rate, and collateral. A note payable, however, cannot be converted to an account payable.
#5. Reason for the liability
Businesses raise an account payable when they cannot pay their suppliers immediately for purchases made. Account Payable is therefore a result of credit purchases that are to be paid back at a later date. Payable on the other hand are loans taken by a business to finance the purchase of fixed assets.
Most often than not, the asset purchased with the piano becomes the collateral security for the loan if the business defaults in paying back the loan on the agreed date.
#6. Agreement requirement
Accounts payable does not require the business to enter into a formal written agreement with the supplier. The credits are given based on the creditworthiness of the business over time. The case is however different with notes payable.
The terms of the loan are formally written down after deliberations by both parties. Each of the parties fully understands their role and the implication of not honoring the terms of the agreement.
#7. Collateral requirement
No collateral is required for an account payable obligation unless the obligation is converted to a note payable. On the other hand, a note Payable most times requires collateral as a security for the loan.
Since note Payable loans are used in the purchase of fixed assets, the asset in question normally becomes the collateral for the loan. The borrower runs the risk of losing the fixed assets if the business defaults in paying back the loan at the agreed time.
Conclusion
Accounts Payable and Note Payable are accounting terminologies that every business should understand. A deep understanding of how each of these concepts works can help the business to make informed decisions that will change the narrative of their operations.
