Businesses sometimes lend money or extend credit to suppliers, customers or others by issuing notes that specify the terms of the loan and a maturity date. The note issuer records the loan in the notes receivable account, an asset. To raise cash quickly, note issuers have the option to sell their notes receivables to a financial institution at a discount. The discount is the product of the note's value at maturity, discount period and discount rate.
Figuring the Discount
Typically, notes receivable are short-term loans that mature in less than one year, although longer maturities are possible. A note's value at maturity is the sum of the remaining interest payments and the principal amount. The discount period extends from the date of the note's sale to its maturity. The financial institution sets the annual discount rate based upon the note's value, the costs of buying and collecting the loan, and a suitable profit margin. For example, suppose a company issues to a supplier a $50,000 note for 90 days and charges 0.9 percent interest, annualized, payable at maturity. The interest after 90 days is (90/365 x .009 x $50,000), or $110.96, which, when added to the principal amount, equals a maturity value of $50,110.96. If the company immediately sells the note to a bank at a 10 percent discount, it pays a discount of (0.10 x $50,110.96), or $5,011.10. The company receives cash equal to the maturity value minus the discount, which is ($50,110.96 - $5,011.10), or $45,099.86.