What is an IOU?
The term IOU is the phonetic spelling of the phrase "I Owe You." In bookkeeping, it signifies an outstanding debt.
How Does an IOU Work?
Usually, an IOU is a signed informal notice of an unpaid debt, sometimes because of partial payment and an outstanding balance due. For example, Company XYZ may buy raw materials for its production but until it sells the finished product, it does not have sufficient cash flow to pay for the raw materials in full. In good faith, Company XYZ makes a partial payment for the materials and issues an IOU for the balance.
Sometimes, a bond contract, the obligation of a bond issuer to repay bondholders, is referred to as an IOU. However, in that case, the IOU or bond contract is a formal legal agreement with specific terms, conditions, and penalties.
An IOU may also be the uncomplicated method of documenting small debts between employees, friends or even family.
Why Does an IOU Matter?
An IOU does not have the same legal requirements or standing as a promissory note or other financial contract. It is usually not witnessed or signed by the lender, nor does it include specific provisions for how or even when it will be repaid. Because of the limited recourse to recover debts under IOUs, they are not usually helpful in securing financing or enforceable in court.