Bonds and notes payable are two types of debt that companies can access to raise capital. Technically speaking, both are written agreements between the company and the lender defining how much will be borrowed, when and how it will be repaid, and how much interest will be paid and when.
These two types of debt are very similar, but there are important differences. Let's dig into the similarities and differences that matter.
Bonds and notes payable have a lot in common
Bonds and notes are both forms of debt. In both cases, a company accepts cash from another entity and is expected to pay back that cash plus interest over time. The exact structure used to decide when and how much principal and interest is repaid can vary widely from one bond to another and from one note payable to another. All of the details of the debt's structure are defined on a contract-by-contract basis.
Bonds and notes both appear on the liabilities side of a company's balance sheet, and the interest paid on each appears as an interest expense on the income statement. In financial terms, bonds and notes are mostly indistinguishable.
For example, most bonds are structured so that the company pays back the entire balance of the debt at one point in the future -- that is, on its maturity date. The company will pay its interest expense periodically over time, typically monthly.
A note payable could be structured identically, but neither necessarily has to be structured in this way or any other way. If they both happened to be identically structured, both would have the same impact on the balance sheet and the income statement. Structurally and practically, the two instruments are identical.
Where the similarities stop
The primary difference between notes payable and bonds stems from securities laws. Bonds are always considered and regulated as securities, while notes payable are not necessarily considered securities. For example, securities law explicitly defines mortgage notes, commercial paper, and other short-term notes as not being securities under the law. Other notes payable may be securities, but that is defined by the law, convention, and regulations.
Generally, the term of the debt is the best way to determine whether it's more likely to be a note or a bond. Shorter-term debts -- those with a maturity of less than one year -- are most likely to be considered notes. Debts with longer terms, excluding the specific notes payable mentioned above, are more likely to be bonds.
A good example of this principle is how the U.S. classifies its own debt offerings. A Treasury note has a maturity between one and 10 years. A Treasury bond has a maturity of more than 10 years. Short-term Treasuries with maturities of less than one year are called Treasury bills.
The three distinctions are largely arbitrary, based on how far in the future each debt will mature. The same general concept is true when determining whether a debt is a bond or a note payable.
The bottom line is that notes payable and bonds are, for all practical purposes, essentially the same thing. They're both debt used by companies to fund operations, growth, or capital projects. Unless you're a lawyer, a professional debt-trader, or a securities regulator, the differences are largely moot.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at email@example.com. Thanks -- and Fool on!
Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.