Lines of Credit versus Notes Payable

A business engages in borrowing transactions to fund its long-term commercial ambitions and prevent its operations from falling by the competitive wayside. Lines of credit and notes payable are part of the company's funding arsenal, although it also can raise money through public conduits. These include physical markets, such as the New York Stock Exchange, and digital platforms -- such as the National Association of Securities Dealers' Automated Quotation, or Nasdaq.

A line of credit is a revolving loan a bank grants a customer, and the client can tap into funds as long as the bank receives interest and principal payments on time. “Revolving” means the creditor replenishes funds in the credit line arrangement after the debtor remits the cash owed. For example, a bank grants an interest-free $100,000 credit line to an organization. The business uses $25,000 to finance operating activities, leaving a balance of $75,000. Two months later, the borrower sends $10,000 to the creditor, bringing the outstanding line amount to $85,000. The business can use this cash to fund other activities and doesn’t need to re-apply for a new loan once it repays the outstanding balance.

A note payable is a document in which one party, the payer, consents to remit to another party, the payee, a certain amount of cash at a specified time. “Payer,” “debtor” and “borrower” as well as “payee,” “creditor” and “lender” are identical terms, respectively. Most lending arrangements start and end with a loan payable, as lenders want to ensure prompt repayment in accordance with the loan covenant and to receive legal protection in case a debtor defaults. Creditors generally monitor the financial profiles of individual and corporate borrowers to evaluate creditworthiness and economic soundness. Borrowers may lose lender support if their actions and financial prognosis make debt repayment more elusive. In that case, lenders could ask for early repayment or increase interest rates to account for credit risk.

Lines of credit and notes payable interrelate in corporate debt administration. Both concepts deal with the way a business raises funds through credit conduits -- unlike equity channels, which pertain to such financial markets as the London Stock Exchange. In essence, credit lines and notes payable lead to corporate debts, if -- and when -- a prospective borrower taps into funds.

To record loan proceeds, a corporate bookkeeper debits the cash account and credits the corresponding debt account. Debiting cash, an asset account, means increasing company money. This is distinct from the banking practice. Notes payable and fully, or partially, tapped credit lines are short-term or long-term debts, depending on the maturity. Both items are integral to the balance sheet.