Differences Between Note Payable & Term Loan

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By engaging in note payable and term loan transactions, corporate leadership helps put operating activities on the competitive map and steer them to financial success. To ease the concerns of lenders and business partners, company principals generally develop a narrative that draws on corporate financial information, especially rosy profit numbers and impeccable solvency trends.

Note Payable

A note payable -- also known as a promissory note, or simply a note -- is a contract in which one party agrees to pay a sum of cash to another party in accordance with the note’s covenant. The borrower, or payer, can repay the sum over several installments -- monthly or quarterly, for example -- or in a lump-sum remittance, usually at the maturity date. Accountants use the terms “creditor,” “lender” and “payee” interchangeably. Most commercial and personal loans qualify as notes payable. For example, if you sign a mortgage contract and the bank advances funds, you’ve signed a note payable.

Term Loan

A term loan is an interest-only debt that spans a specified term, and the borrower repays the principal amount only at loan expiration. This is the other term for maturity. The duration of a term loan typically extends to 10 years. For example, assume a company’s leadership signs a term loan of $1 million with interest at 10 percent, and the debt is payable over a five-year period. The business will remit annual interest of $100,000 ($1 million times 10 percent) over each of the next five years, assuming a simple-interest calculation method. At the end of the fifth year, the organization will send lenders a $1 million check to settle the debt.

Connection

Term loans and notes payable are part of a company’s fundraising arsenal, along with such borrowing arrangements as bonds payable and accounts payable. The interrelation between these instruments also extends to the realm of financial reporting, as accountants classify them as debts on a corporate balance sheet. Generally speaking, a term loan is always a note payable, but the opposite may not be true. This is because a note payable may not be an interest-only debt and may feature a variable, fixed or fixed-variable interest rate arrangement.

Financial Accounting and Reporting

When a company borrows short-term or long-term cash -- whether it be a note payable or term loan -- a bookkeeper makes specific entries. The junior accountant debits the cash account and credits the corresponding debt account, depending on loan maturity. For example, the bookkeeper credits a short-term liability account if the repayment window is 12 months or less. In accounting terminology, debiting cash means increasing company money, which is contrary to the banking concept.

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