In business, things move fast. And when they move, you’ve got to track them. This includes anything and everything related to finances: like loan payments.
But where to start? What to record? How to record? And what is a journal entry in the first place?
You’ve got lots of questions, and we’ve got lots of answers. All explained simply and quickly so you can get back to doing what you do best: running your business like a boss. Which, in case you forgot, you are.
How to record loans and loan payment journal entries
Many small businesses have taken out loans. Sometimes, a loan is how you get your company up-and-running in the first place, and other times, loans are required for business decisions that need to be made, like a strategic pivot or an expansion.
Loans can be either short-term or long-term. A short-term loan means repayment occurs in less than a year. Long-term loans are repaid in over a year’s time.
In this blog, when we say “loans,” we mean both loans received and the loan payments themselves. These take four steps to record.
Step 1: Record the initial loan
Recording the initial loan is the first step of the payment process. This is an official record within your accounting software. It shows that you’ve received the loan, and outlines the loan liability.
For instance, if your loan is short-term, you would record it as a current liability. If it’s a long-term debt, it’s incurred as a long-term liability.
Recording your loan accurately is an important part of this process. To do so, you’ll enter a “debit” to the “cash account.” By entering a debit to your cash account, you’re recording the cash receipt, which is the official accounting entry that records the payment.
But before we go further, let’s review two accounting definitions: a debit and a cash account.
- A debit is an increase in assets or a decrease in liabilities or equity. It doesn’t necessarily indicate a business has more available money to work with.
- A cash account, also called a cash book, refers to the ledger that records all cash transactions. It includes both the cash receipts journal and the cash payment journal.
Next, you’ll enter a credit to the related loan liability account for the outstanding loan.
Step 2: Record the loan interest
Loan interest: potentially our least favorite part about loans. Depending on your lender and the type of loan you’ve incurred, you’ll be charged interest on periodic bases. This could be monthly or semi-monthly, but no matter the type, be sure to know the details so that your interest is paid out on a similar payment schedule.
Back to recording. Just like when you recorded the initial loan, you’ll also need to record its interest. And that involves one major rule: your business has to recognize the interest expense on the same periodic basis and treat it as an expense.
Let’s pull out our dictionary again:
- An interest expense is defined as the cost you’re incurring on your borrowed funds. It’s a non-operating expense that shows up in your statements.
So remember: even if there’s no interest due at the time of recording, you must account for the cost that’s about to come.
Step 3: Record the interest payments
Let’s focus on the interest payments themselves. If you made a payment after the interest has been accumulated and recorded, don’t worry! This happens.
Interest payments won’t cause another interest expense. When you record your interest payment, simply enter it in your books as a debit to the “Interest Payable” account.
To debit the "Interest Payable" account, enter the amount of interest payment as a debit in your books. This reduces the amount of money you owe for interest.
To credit the "Cash" account, enter the same amount as a credit in your cash account. This shows that you have paid that amount of interest.
By doing these two things, you’re removing the interest that’s growing, and instead, recording your payment for the interest amount.
Step 4: Record the loan payment
The final step: recording the actual loan payment. 👏
This will differ depending on the type of loan you have: unamortized, amortized, and periodic. Before you proceed, know which type is yours. This is critical for tracking, and of course, repaying on time. We’ll review definitions and how they work below.
An unamortized loan is a type of loan where the borrower doesn’t make regular payments to cover the principal amount and the accrued interest. Instead, they may only have to make interest payments during the loan term, which doesn’t impact the remaining principal amount (the initial amount of money borrowed.
Once your loan reaches its end date and is supposed to be repaid, your principal amount is due, an unamortized loan repayment will need to be recorded.
First, you must debit the loan account. This is an entry that shows a decrease in liability, like reducing the amount you owe to the lender. This reduces the liability on your financial records. At the same time, you’ll credit the cash account to reflect the actual cash payment you’ve made toward the loan.
Amortized loans is a type of loan where you’re making regular payments over a set period of time. These will cover both the interest charges and the gradual reduction of the principal amount you’ve borrowed. When you’re recording this, you’ll separate each payment into interest expense and principal payment amounts.
A loan with periodic payments requires you make regular, recurring payments at specific times during the borrowing period, like monthly, quarterly, or annually.
If you’re recording periodic loan payments, you’ll start by applying the payment toward the interest expense. You’ll then debit the remaining amount to the loan account. This will result in a reduction of the balance you have outstanding, and then the cash account will be credited to record the cash payment.
Loan payment journal entry FAQs
What are journal entries in accounting?
In accounting, journal entries are how you record your financial transactions, including loan payments. They’re called journal entries because—back in the day—accountants and bookkeepers recorded transactions in a paper journal.
No matter how you track your finances, every journal entry must consist of three things: the date of the journal entry, the debit side of the journal entry, and the credit side of the journal entry.
What are loan payments?
A loan payment is repayment to your financial lender. It typically includes the total payment amount, an interest payment (which is recorded as an expense), a principal payment (recorded as a reduction of a liability, like a loan payable) that reduces the total amount owing on your loan.
Are loan payments business expenses?
Not every part of your loan payment is considered to be a business expense. For instance, while the interest payment portion is considered an expense, the principal payment portion of the loan payment is actually considered to be a loan payable or a notes payable—not an expense.
When using the accrual method of accounting—which enables your business to record revenue before you’ve received payment and also record expenses as they are incurred—your interest expenses and liabilities are instead recorded at the end of each accounting period. To do this, adjust entries to match the interest expense to the appropriate period.
Are loan payments recorded on income statements?
Only the interest portion of a loan payment will appear on your business’s income statements. This will be noted as "interest expense."
In addition, the reduction of liability will be reported on your balance sheet (the financial statement that provides a snapshot of your business’s financial health at a particular date in time, including debts owed) and the principal payment will reported as a cash outflow on the your cash flow statement: a financial report of every transaction where your business earned or spent cash or cash equivalents within a certain period of time.
Start recording loan payment journal entries now
Repaying a loan (and recording it accurately!) is a step-by-step process. It involves recording your initial loan, the loan interest, and the payments you make on both. It also depends on the type of loan you’ve taken out: amortized, unamortized, or periodic.
Wave, one-stop money management for small business owners, makes typically-intimidating-stuff like loan repayment journal entries feel as easy as those diary entries from your childhood: save for the dramatic tears, lyrical references, and secret code words. IYKYK.
But if you do need help along the way, our team of bookkeeping, accounting, and payroll experts is standing by to coach you—or do the work for you. We’ve got your back.
The information and tips shared on this blog are meant to be used as learning and personal development tools as you launch, run and grow your business. While a good place to start, these articles should not take the place of personalized advice from professionals. As our lawyers would say: “All content on Wave’s blog is intended for informational purposes only. It should not be considered legal or financial advice.” Additionally, Wave is the legal copyright holder of all materials on the blog, and others cannot re-use or publish it without our written consent.