From a handshake to a signature
By now you know what an ordinary account receivable is: when you sell on credit, you record revenue and a claim to be paid, and you carry that claim at the realistic amount you expect to collect. Most of the time that informal arrangement is enough — the customer is reliable, the bill is small, and the cash shows up within a month. But sometimes a casual 'I'll pay you soon' is too flimsy to lean on. The amount is large, the wait will be long, or a customer has already drifted past due. In those moments a business wants something firmer than a verbal promise. It wants the debt in writing, with a date and a signature on it.
That written, signed promise is a promissory note, and the claim it creates on your side of the deal is a note receivable. Think of the difference as a verbal IOU versus a contract you could actually take to court. The note spells out three things precisely: the principal (the face amount owed), the interest rate (an annual percentage charged for the wait), and the maturity date (the day it must be paid in full). Because all three are nailed down, a note is a stronger, more enforceable claim than an open account — and, crucially, it usually charges interest, which an ordinary trade receivable does not.
Where does a note come from? Two common doorways. First, a sale: instead of letting a customer pay on open account, the seller asks them to sign a note up front — typical for a big-ticket item or a long payment window. Second, and very common, a rescue: a customer's ordinary account has gone overdue, and rather than write it off, the seller converts that stale receivable into a note. The customer gets more time; the seller gets a firmer claim and starts charging interest for the extension. Either way, a note due within a year sits among current assets; one stretching beyond a year is non-current.
Trade receivable versus note: same family, different muscle
It helps to lay the two claims side by side, because they are cousins, not strangers. A trade receivable arises automatically from the ordinary cycle of selling on credit; a note receivable is a deliberate, signed instrument. A trade receivable carries no interest and is expected within about 30 to 90 days; a note carries an explicit interest rate and can run for months or years. A trade receivable is documented by an invoice and your own ledger; a note is documented by a signed promissory note that names the parties, the principal, the rate, and the due date. The everyday muscle of the business runs on trade receivables — but when a debt needs reinforcing, it gets upgraded to a note.
There is a second cousin worth naming so you don't confuse it: notes *payable*. The very same piece of paper looks different depending on which side of the desk you sit. To the company that holds the note and will collect, it is a note receivable, an asset. To the company that signed it and will pay, the identical note is a note payable, a liability. One document, two mirror-image entries on two sets of books — a small reminder that every claim is somebody else's obligation.
Interest: rent on money, earned by the day
Why does a note carry interest when a plain account does not? Because money has a time value: a dollar you must wait a year to collect is worth less to you than a dollar in hand today, since you could have put today's dollar to work. Interest is simply the rent the borrower pays for using your money over time. When you hold a note receivable, that interest is interest revenue — extra income earned purely for the wait, separate from whatever you sold in the first place.
The arithmetic is refreshingly simple. Interest equals principal times the annual rate times time, where time is written as a fraction of a year. A note for 10,000 at 6% for a full year earns 10,000 × 6% × (12/12) = 600. The same note for only four months earns 10,000 × 6% × (4/12) = 200. Notice the rate is always *annual*, so you must scale it by how much of a year the money was actually owed — a six-month note at 8% earns half of 8%, not 8%. That little fraction is where most beginners slip.
One more placement detail, since you have already met the income statement. For a company whose main business is selling goods or services, lending is a sideline, so interest revenue lands among non-operating items rather than in the headline operating revenue. It still adds to net income — it just sits below the line that measures how the core business performed. The cash a customer hands over at maturity, principal plus interest, is the same cash either way; the income statement merely keeps the operating story and the lending story in separate drawers.
Accruing interest at period-end
Here is where this guide leans on a lesson you already climbed past. Interest does not arrive in a lump at maturity; it is *earned continuously*, a sliver each day the customer holds your money. But a note rarely lines up neatly with your accounting calendar. Suppose you accept a note on October 1 that matures next April 1, and your books close on December 31. By year-end you have earned three months of interest even though not a cent has been paid. Ignoring it would understate this year's income and overstate next year's — exactly the timing problem accrued revenue exists to fix.
The cure is an adjusting entry at period-end. You compute the interest earned *so far* and record it now, before any cash moves: debit a new asset called Interest Receivable, and credit Interest Revenue. This is pure accrual thinking — recognize the income in the period you earned it, not the period the cash arrives. The Interest Receivable that appears on the balance sheet is simply interest the customer owes you but hasn't paid yet, a separate little claim sitting beside the note's principal.
Note: 10,000 principal, 6% annual, signed Oct 1, matures next Apr 1 (6 months)
Total interest over the note's life: 10,000 x 6% x (6/12) = 300
Dec 31 (this year, 3 months earned) adjusting entry:
Dr Interest Receivable 150 <- 10,000 x 6% x (3/12)
Cr Interest Revenue 150 <- earned this year
Apr 1 (next year, at maturity) collection entry:
Dr Cash 10,300
Cr Notes Receivable 10,000 <- principal returns
Cr Interest Receivable 150 <- last year's accrual, now paid
Cr Interest Revenue 150 <- 3 more months earned this yearTurning receivables into cash today: factoring and assignment
A receivable, whether an ordinary account or a note, is an asset — but it is an asset locked in the future. The cash is real, yet it is 30, 60, or 180 days away, and a business with bills to pay this week cannot eat a promise. So a whole market exists for *unlocking* receivables early: selling or borrowing against them to get cash now instead of later. Two arrangements do this, and the difference between them is who ends up owning the receivable.
Factoring is an outright *sale* of receivables. The company sells its claims to a third party — a factor — for cash right now, but at a discount: the factor pays, say, 96,000 for 100,000 of receivables, keeping the 4,000 spread as its fee for fronting the money and bearing the collection effort. The receivables leave the seller's balance sheet entirely; the customers may even be told to pay the factor directly. Assignment (or pledging) is gentler: the company *borrows* cash and offers its receivables as collateral, the way a house secures a mortgage. The receivables stay on the company's books, the customers keep paying the company, and that incoming cash is used to repay the loan. Sale versus loan — that is the heart of the distinction.
Why pay a factor 4,000 to receive 96,000 you could have collected in full? For speed and certainty. The factor's discount is the price of cash today and, often, of offloading the risk and bother of chasing slow payers. There is a fine point worth knowing: factoring can be *with recourse* (if a customer never pays, the seller must make the factor whole, so the seller still shoulders the bad-debt risk) or *without recourse* (the factor eats any uncollectible accounts, which is why it charges more). None of this is exotic finance — it is the everyday plumbing by which businesses convert tomorrow's receivables into today's payroll.