What is a Promissory Note?

//What is a Promissory Note?
What is a Promissory Note? 2017-10-09T07:35:38+00:00

Definition: A promissory note is a written agreement to pay a specific amount to specific party at a future date or on demand. In other words, it’s a written loan agreement between two parties that requires the borrower to pay the lender on a day in the future. This could be a set date or a date chosen by the lender.

What Does Promissory Note Mean?

What is the definition of promissory notes? Promissory notes usually refer to the borrower as the maker of the note. The borrower generally is said to have made the written agreement because he or she is initiating the transaction. The lender is referred to as the payee because it is the party that first pays the money to the borrower and then receives the payments at a future date. I know this is confusing. Just remember the maker is the borrower and the payee is the lender.

Businesses use notes to finance many different operations. Some companies use short-term notes to finance inventory purchases while other businesses use long-term notes to raise enough capital to purchase large equipment and machinery. Really this note is just a fancy way of saying a loan. Let’s take a look at an example.

Example

Ken’s Pizzeria is having problems with its oven and needs to purchase a new one. Unfortunately, it doesn’t have enough money to purchase one outright, so it approaches a bank. Ken, the maker of the note, asks the bank for $25,000 to purchase its new oven. The bank, the payee, reviews Ken’s financial statements and agrees on a 5-year note that pays 10 percent interest.

The official loan agreement is put in writing including the issue date, original principle amount, repayment date, rate of interest, and names of each of the parties involved. Remember, a promissory note is always in writing. If Ken gets a loan from a friend and doesn’t have a written agreement, it can’t possibly be a promissory note.

Summary Definition

Define Promissory Notes: A promissory note is a written contract that requires a borrower to pay back a lender an amount of money on a future date.