Business loans: separating principal, interest and fees

A business loan looks like one simple payment leaving the bank each month, but recording it as a single expense is wrong and quietly corrupts both the profit-and-loss and the balance sheet. Every repayment is really two things at once — returning borrowed money and paying for the privilege of borrowing it — and the books have to split them. This guide explains how to record loans, repayments, and fees correctly.

The loan is a liability

When a loan is drawn down, the business receives cash but has not earned income — it has taken on a liability. So the loan is recorded as a liability on the balance sheet, with cash going up by the same amount. Nothing about receiving the loan touches the profit-and-loss. This starting point is what makes the rest follow: because the money was never income when it arrived, repaying it cannot be an expense when it leaves.

Splitting each repayment

Each repayment is divided into two parts, recorded against two different accounts:

• The principal portion reduces the loan liability — it is returning borrowed money, not a cost.
• The interest portion is an expense on the profit-and-loss — it is the charge for borrowing.

So a single payment out of the bank hits both the balance sheet (principal down) and the profit-and-loss (interest expense). The frequent error is booking the whole payment as an expense: that overstates costs, understates profit, and leaves the loan balance overstated because the principal repayments were never applied to it. Only the interest is an expense.

Use the amortization schedule

The split between principal and interest is not a guess — it comes from the loan's amortization schedule, which the lender provides. It breaks every scheduled payment into its principal and interest components. A feature worth understanding: in a typical amortising loan, the early payments are mostly interest and the later ones mostly principal, even though the payment amount is level. Recording each month from the schedule keeps the split correct as it shifts over the life of the loan.

Loan fees and where loans connect

Loan fees — arrangement or origination charges — are a third element to handle rather than lump into the repayment. Depending on their nature and the amounts, a fee may be expensed or spread over the life of the loan, which overlaps with how prepaid and accrued items are treated; where a fee is significant, confirm the correct treatment. Loans often fund the purchase of equipment, so they sit alongside the fixed-asset register, and their scheduled repayments are part of what payables discipline and the monthly close keep on track. Recorded properly, a loan tells you clearly how much you still owe and how much borrowing is costing you — two things a single expense line would hide.

Sources

This guide is written against the official and clearly labelled professional references below. Rates, thresholds and portal procedures change between reviews, so open the primary source before relying on a figure.

• Recordkeeping (IRS)
• Businesses (Internal Revenue Service)

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