As the saying goes, you have to spend money to make money. Companies have to pay for a seemingly endless list of supplies, equipment, services, and more to keep business running. Depending on the size of your company, this list of expenses can add up quickly. Determining how much is owed, and figuring out who to pay and when can be a cumbersome exercise. So how do companies keep track?
Organizations use accounts payable (AP) and notes payable (NP) to monitor debts owed to banks, merchants, or specialized professionals. Because AP and NP are both documented as liabilities on a balance sheet, people are often confused by their differences. But understanding both principles is key to managing debt and making on-time payments.
In this article, we define accounts payable and notes payable, outline the main distinctions between the two, and provide some tips on how to better manage accounts payable.
What Is Accounts Payable?
Before we get too far into describing the differences between accounts payable and notes payable, we need to start with the basics. Accounts payable is defined as money owed to suppliers or contractors within a year or less. These debts represent services or supplies bought on credit, so they’re reflected as liabilities on a balance sheet. And because companies often engage with the same vendors regularly, purchases aren’t usually associated with official agreements like a loan would be. AP entries serve as a reminder to a company’s finance team to pay invoices in the short term.
Some examples of accounts payable expenses might be new inventory, furniture or supplies, consulting services, or office-related utilities. As you might imagine, everyday invoices stack up quickly. While companies can handle accounts payable manually, it’s becoming increasingly common for smart companies to automate the processes tied to accounts payable.
What Is Notes Payable?
Notes payable represent liabilities owed to financial institutions captured in the form of formal promissory notes. A notes payable is effectively a loan agreement, containing information related to payment deadlines and interest rates. NPs are recorded in the general ledger to ensure debts are repaid in full accordance with the agreement.
Notes payable can represent either short-term or long-term liabilities, depending on the payment stipulations in the signed promissory note. If the note specifies to pay the debt within a year, it would be considered a short-term liability. If repayment can occur over a period longer than one year, the note is designated as a long-term liability. Notes payable are often used to purchase things like commercial buildings, industrial equipment, company cars or trucks, or other significant procurements that require a loan.
What’s the Difference Between Accounts Payable and Notes Payable?
Many people use the terms AP and NP interchangeably, but there are some stark differences between the two. Accounts payable refers only to short-term liabilities, but notes payable can represent either short-term or long-term liabilities and is contingent upon due dates and terms summarized within the note. Another way to think about it is that accounts payable liabilities are usually more of your day-to-day expenses that keep the lights on, whereas notes payable liabilities are issued for more substantial purchases.
However, there are more differences between the two. Below, we expand on those in more detail:
1. FORMALITY OF AGREEMENT
Accounts payable: AP entries are generally informal verbal agreements, rather than formal contracts.
Notes payable: Since notes payable have more stipulations, like repayment terms, to cover, they are always written, formal agreements.
2. SPECIFIC TERMS
Accounts payable: Accounts payable payments rarely have specific terms. Oftentimes, AP entries just have a due date, a fee for late payment and maybe a discount for early payment,without mentioning specific obligations to creditors.
Notes payable: Notes payable, on the other hand, list maturity periods, interest rates, payment schedules, and clauses related to non-payment. These terms are put in place the moment a promissory note is signed.
3. TIMELINE FOR PAYMENT
Accounts payable: As described earlier in this piece, AP entries must be paid within 12 months or less.
Notes payable: A notes payable entry might be paid within a year (making it a short-term liability), or longer than one year (making it a long-term liability).
4. ABILITY TO CONVERT IN THE LEDGER
Accounts payable: If necessary, accounts payable entries can be converted to notes payable. This might occur if a business needs longer than 12 months to pay the AP entry.
Notes payable: By contrast, NPs can never be converted to accounts payable. They are treated as a fixed, signed agreement.
5. WHO RECEIVES PAYMENT
Accounts payable: Accounts payable entries typically stem from relatively smaller, regular purchases, so vendors, suppliers, and subcontractors are generally the recipients.
Notes payable: Notes payable are tied to buying enterprise assets or borrowing large sums of money. As such, credit companies and banks are the receipts of notes payable payments.
Accounts payable: Since accounts payable entries denote more common expenses, they’re considered low risk. Many companies are good at paying off their invoices and have good credit.
Notes payable: Notes payable are created in the case of high-risk customers who have a poor or unknown credit history or for high-risk lines of credit for large sums of money. Consequently, NPs have predetermined terms and accrue interest over time.
7. TYPE OF LIABILITY
Accounts payable: As described earlier in this article accounts payable entries are recorded as a short-term liability.
Notes payable: Notes payable entries can be logged as either short- or long-term liabilities pursuant to the promissory note.
8. IMPACT ON A COMPANY’S CAPITAL
Accounts payable: Accounts payable plays a role in calculating the capital that’s available for a business’s day-to-day operations.
Notes payable: Notes payable can also impact working capital estimates depending on the type of liability it is. NPs that are short-term liabilities can be used to estimate current capital just like APs but otherwise aren’t appropriate for forecasting.
Take Advantage of Automation
Knowing the differences between accounts payable and notes payable helps accounting teams prioritize payments in a way that supports the growth of their business. With a birds-eye view into short- and long-term working capital, keeping accounts payable and notes payable entries accurate and up-to-date helps companies run more smoothly.
That said, managing notes payable and particularly accounts payable can be challenging. Many companies struggle with handling invoices一both physical and digital. And they spend an extraordinary amount of time trying to ensure data from invoices are keyed into their system accurately.
The good news is that your teams don’t have to handle accounts payable manually. MHC offers a comprehensive procure-to-pay solution that makes it easy for accounting departments to streamline their AP processes. With features like OCR technology and automated invoice routing, MHC eliminates errors that stem from manual data entry and reduces bottlenecks that crop up in the invoice approval process, saving you time and money. Plus, it seamlessly integrates with ERP solutions from providers like Infor, Oracle, and Microsoft Dynamics.
Want to learn more about how MHC can help you improve your accounts payable processes? Discover the MHC NorthStar platform!