Calculate Interest on Note Receivable
Overview
The company may sometimes grant credit to others (e.g. its customers) in exchange for the note receivable it receives in the form of a promissory note. In this case, it needs to properly calculate the interest on note receivable that it will earn in the future date. This is so that the company can determine whether such extra revenue (i.e. interest on the note) will outweigh the risk that it bears in this type of credit transaction.
Similar to the accounts receivable, the note receivable grants the right to the company in receiving the payment from the maker of the note in the future date. However, the note receivable has a stronger claim than the accounts receivable as it is written in the formal form of the promissory note.
Calculate interest on note receivable
The company can calculate the interest on note receivable by using the face value of the note to multiply with the interest rate and the time in the maturity of the note.
Interest on note receivable = Face value of the note x Interest rate x Time
- Interest rate: the interest rate on note receivable that is usually expressed as an annual rate.
- Time: the maturity of the note that is usually expressed in a fraction of a year which is matched with the annual interest rate.
For example, if the maturity of the note receivable is stated as 90 days, the time in the formula above will be converted to the fraction of a year by using 90 to divide by 360 (90/360).
On the other hand, if the maturity of the note is stated in months, the time in the formula of interest on note receivable will be converted to the fraction of a year by dividing it by 12 (number of months / 12)
Interest on note receivable example
For example, on January 01, the company ABC receives a $2,000 note receivable from one of its customers. The note receivable has a 180 days maturity with an annual interest of 12%.
In this case, the company ABC can calculate the interest on note receivable as below:
Intterest on note receivable = 2,000 x 12% x 180/360 = $120
As a result, the interest on a $2,000 note receivable above is $120. Likewise, the company will receive the payment of $2,120 ($2,000 of note plus the interest of $120) at the end of 180 days of maturity.