Notes receivable: Definition, formula, and examples

A note receivable is a signed agreement where a borrower commits to repaying your business a fixed sum, with interest, by a set date. Unlike a standard invoice on open credit, it's legally binding and generates interest income.

This article covers how to calculate interest, record journal entries, and manage notes receivable.

What is a note receivable?

A note receivable is a signed promissory note where the maker agrees to pay the payee a specific principal amount, plus interest, by a set maturity date. You record it as an asset on your balance sheet.

A standard AR balance comes from a routine sale on credit, usually with no interest and short payment terms. A note receivable involves a signed document with a stated interest rate, a defined repayment schedule, and legal enforceability if the maker defaults.

Current vs. non-current classification

How you classify a note receivable on your financial statements depends on when it matures. If the note is due within one year or your normal operating cycle, it's a current asset. If it extends beyond that, it goes on the balance sheet as a non-current asset.

This classification affects your liquidity ratios and how lenders and investors evaluate your working capital. A large portion of your receivables sitting in long-term notes can make your current ratio look weaker, even when the notes are performing.

Key components of a promissory note

Every promissory note has six core elements:

• Principal: The face value of the note. This is the starting number you use when calculating interest
• Maker: The party who signs the note and promises to pay. On their books, they record it as a note payable. On yours, it's the receivable
• Payee: You, the party receiving the promise of payment. You hold the note as an asset until it's collected
• Interest rate: The annual percentage the maker pays on top of the principal
• Maturity date: The specific date the full payment, principal and interest included, is due. Some notes mature in 30 or 60 days, while others run for a year or longer
• Repayment terms: Whether the maker pays in a lump sum at maturity or in installments over time. The terms also specify what happens if the maker misses a payment or defaults entirely

How do notes receivable differ from accounts receivable?

Both notes receivable and accounts receivable represent money owed to your business, but they work differently in practice. You typically create an AR balance when you ship a product or deliver a service, send an invoice, and expect payment within 30 to 90 days.

There's no signed contract beyond the invoice itself, and interest usually doesn't come into play unless the balance goes past due. Notes receivable are more structured, involving a signed promissory note with an explicit interest rate and a defined maturity date.

You often create them when a customer can't pay an outstanding AR balance on time and both parties agree to formalize the debt with better terms. They also come up when you lend money to an employee or subsidiary, or when a large transaction needs a longer repayment window than standard net terms allow.

How do notes receivable differ from notes payable?

Notes receivable and notes payable are two sides of the same instrument. If you hold the promissory note and expect to collect payment, it's a note receivable, an asset on your books. If you signed the note and owe the money, it's a note payable, a liability under accounts payable.

The same $50,000 promissory note appears as a receivable for the payee and a payable for the maker.

When do businesses use notes receivable?

Notes receivable come up in five common situations.

Converting overdue accounts receivable

The most common scenario is converting an overdue AR balance into a formal note. When a customer can't pay within standard terms, you can offer a promissory note that gives them more time while protecting you with a signed agreement and interest income.

Lending to employees or subsidiaries

When your company extends a loan to an employee or a subsidiary, you typically document it with a promissory note. This creates a clear record of the principal, interest rate, and repayment schedule. It also ensures the loan shows up on your general ledger as an asset rather than an expense.

Large trade credit transactions

For high-value sales where the buyer needs extended payment terms, a note receivable provides more security than a standard invoice. A $200,000 equipment sale paid over 18 months, for example, is better documented with a signed note that specifies interest and a payment schedule.

Installment payment arrangements

When a buyer needs to spread payments over time, you can structure the deal as an installment agreement from the start. Each payment reduces the principal while you recognize interest revenue along the way.

Settling disputes or restructuring debt

When two parties settle a financial dispute or restructure existing debt, a promissory note can formalize the new terms.

How to calculate interest and maturity value

Two formulas determine the interest and maturity value of a note receivable.

Interest calculation

To calculate interest earned on a note, multiply the principal by the annual interest rate, then multiply by the fraction of the year the note covers.

Interest = Principal x Annual interest rate x (Time in days / 360 or 365)

Many businesses use a 360-day year for this calculation, a convention known as the Banker's Rule. Others use 365 days. Your company's accounting policy determines which one to apply.

For example, if you hold a $10,000 note at 6% annual interest for 90 days using a 360-day year, the interest earned is $10,000 x 0.06 x (90 / 360) = $150.

Maturity value

The maturity value is the total amount the maker owes you when the note comes due. It's the original principal plus all accrued interest.

Maturity value = Principal + Interest

Using the same example, the maturity value would be $10,000 + $150 = $10,150.

How to record notes receivable

Recording notes receivable involves three types of journal entries, from issuance through collection.

Recording the note at issuance

When you first receive a promissory note, you debit Notes Receivable for the principal amount and credit the account that generated it. If you're converting an overdue invoice, you credit Accounts Receivable. If you're lending cash, you credit Cash.

Accruing interest at period end

If a note spans an accounting period, accrue the interest earned but not yet collected. You do this by debiting Interest Receivable and crediting Interest Revenue. This follows accrual accounting principles, recognizing revenue when it's earned rather than when cash arrives.

Collecting the note at maturity

When the maker pays in full, you debit Cash for the maturity value. Then you credit Notes Receivable for the principal, Interest Receivable for any previously accrued interest, and Interest Revenue for any remaining interest earned since the last accrual.

The split between Interest Receivable and Interest Revenue depends on how much interest you accrued in a prior period versus how much was earned in the current one.

What are the common risks with notes receivable?

Notes receivable carry three main risks:

Default risk

A promissory note is legally enforceable, but collecting on a defaulted note still takes time and legal resources. When a note is dishonored, you typically reverse the note receivable entry. From there, you either reclassify the balance as an accounts receivable or write it off against an allowance for doubtful accounts.

Liquidity constraints

Notes receivable tie up cash until maturity. If a significant portion of your receivables are locked into long-term notes, your cash flow can tighten even when the underlying assets are performing.

Record-keeping complexity

Each note requires you to track its principal, interest rate, maturity date, accrual schedule, and payment status separately. As the number of outstanding notes grows, the administrative burden increases. Missing an accrual entry or a maturity date creates errors in your financial reporting.

How to manage notes receivable

1. Centralize your notes receivable ledger

Keep all outstanding promissory notes in a single, up-to-date ledger or subledger that feeds into your general ledger. Each entry should include the maker, principal, interest rate, issuance date, maturity date, and payment status.

2. Set up automated maturity reminders

Set up automated alerts that notify your team before each maturity date so you can prepare for collection.

3. Accrue interest consistently at each period close

Every time you close a month or quarter, accrue the interest earned on each outstanding note. Consistent accruals prevent large catch-up adjustments at year-end.

4. Establish a policy for dishonored notes

Decide in advance how you'll handle notes the maker doesn't pay at maturity. Your policy should cover whether you reclassify the balance, add penalty interest, or send it to collections.

5. Review your notes receivable portfolio regularly

At least once a quarter, review the full portfolio of outstanding notes. Look at aging, concentration risk from too much owed by one maker, and whether any notes should be reclassified from current to non-current based on updated maturity expectations.

Keep the rest of your invoice work moving

Notes receivable carry their own repayment terms and accounting treatment. The day-to-day invoice work around customer balances still needs to happen on time, with the right details and a clear record of what has been paid.

Ramp’s newly released AR software helps finance teams coordinate that work in one place:

• AI invoice creation pulls billing details from source documents into a draft invoice for finance to review
• AI collections agent prepares follow-up based on your collections policy, invoice status, and buyer context. Finance reviews, edits if needed, and sends
• AI cash application matches incoming payments to open invoices and applies them automatically

See how Ramp Accounts Receivable can keep invoice, follow-up, and payment activity connected.