An IOU is an informal document that acknowledges a debt owed, and this debt does not necessarily involve a monetary value as it can also involve physical products. The informal nature of an IOU means there may be some uncertainty about whether it is a binding contract, and the legal remedies available to the lender may be different from those involving formal contracts such as a promissory note or bond indenture. Because of this uncertainty, an IOU is generally not a negotiable instrument during litigation or negotiations.
BREAKING DOWN ‘IOU’
Due to the informality of IOUs, those issuing the IOU are given free reign when writing and issuing it. Criteria, such as time, date, interest and payment type, are not mandatory but may be implied. The term “IOU” is an abbreviation, in phonetic terms, of “I owe you.”
Jimmy’s Hardware places an order for a raw materials. However, the company does not have enough cash to pay for the entire order. Instead, it pays for a partial order and issues an IOU in good faith to pay for the rest of the raw materials at a later date. The IOU could say Jimmy’s Hardware pays the outstanding balance 30 days after the first payment with or without interest.
An IOU may simply serve as a way to put a transaction in writing for later consideration. The document also comes in handy for loans made to a person or business that wants to illustrate an amortization table over a period of time. With an IOU form for a loan, a repayment schedule is a must. The amount of the loan, any interest payments, payoff amounts and the frequency of installments are all considerations a party may include in an IOU form. However, an IOU may deal with credit accounts in the receivables department.
A company’s IOU is counted as an asset on the balance sheet because another party owes that company money or goods. This usually happens when a business provides products or services to be paid later, such as after 30 or 90 days for short-term agreements. An IOU for outstanding receivables is a current asset if the term is one year or shorter. For IOUs longer than a year, accountants consider this a long-term asset. One innovative company sought to take advantage of cash-strapped companies with outstanding IOUs in 2008 in the middle of the financial crisis.
The Receivables Exchange offers an online marketplace for companies to receive cash for their IOUs at a slight discount. The company makes money by cashing in the full amount of the IOU. As an example, Danish Trash company has an outstanding IOU to Adam Plastics for RM500 for the next 30 days. The Receivables Exchange might buy the IOU for RM450 and give the cash to Danish Trash. The Receivables Exchange then gets the full RM500 from Adam Plastics after a month, giving the firm a RM50 profit on the deal.