What Is an Angel Investor?

An angel investor (also known as a private investor, seed investor or angel funder) is a high-net-worth individual who provides financial backing for small startups or entrepreneurs, typically in exchange for ownership equity in the company. Often, angel investors are found among an entrepreneur’s family and friends. The funds that angel investors provide may be a one-time investment to help the business get off the ground or an ongoing injection to support and carry the company through its difficult early stages.

Understanding Angel Investors

Angel investors are individuals who seek to invest at the early stages of startups. These types of investments are risky and usually do not represent more than 10% of the angel investor’s portfolio. Most angel investors have excess funds available and are looking for a higher rate of return than those provided by traditional investment opportunities.

Angel investors provide more favorable terms compared to other lenders, since they usually invest in the entrepreneur starting the business rather than the viability of the business. Angel investors are focused on helping startups take their first steps, rather than the possible profit they may get from the business. Essentially, angel investors are the opposite of venture capitalists.

Angel investors are also called informal investors, angel funders, private investors, seed investors or business angels. These are individuals, normally affluent, who inject capital for startups in exchange for ownership equity or convertible debt. Some angel investors invest through crowdfunding platforms online or build angel investor networks to pool capital together.

Origins of Angel Investors

The term “angel” came from the Broadway theater, when wealthy individuals gave money to propel theatrical productions. The term “angel investor” was first used by the University of New Hampshire’s William Wetzel, founder of the Center for Venture Research. Wetzel completed a study on how entrepreneurs gathered capital.

Who Can Be an Angel Investor?

Angel investors are normally individuals who have gained “accredited investor” status but this isn’t a prerequisite. The Securities and Exchange Commission (SEC) defines an “accredited investor” as one with a net worth of $1M in assets or more (excluding personal residences), or having earned $200k in income for the previous two years, or having a combined income of $300k for married couples. Conversely, being an accredited investor is not synonymous with being an angel investor.

Essentially these individuals both have the finances and desire to provide funding for startups. This is welcomed by cash-hungry startups who find angel investors to be far more appealing than other, more predatory, forms of funding.

Sources of Funding

Angel investors typically use their own money, unlike venture capitalists who take care of pooled money from many other investors and place them in a strategically managed fund.

Though angel investors usually represent individuals, the entity that actually provides the funds may be a limited liability company (LLC), a business, a trust or an investment fund, among many other kinds of vehicles.

Investment Profile

Angel investors who seed startups that fail during their early stages lose their investments completely. This is why professional angel investors look for opportunities for a defined exit strategy, acquisitions or initial public offerings (IPOs).

The effective internal rate of return for a successful portfolio for angel investors is approximately 22%. Though this may look good for investors and seem too expensive for entrepreneurs with early-stage businesses, cheaper sources of financing such as banks are not usually available for such business ventures. This makes angel investments perfect for entrepreneurs who are still financially struggling during the startup phase of their business.

Angel investing has grown over the past few decades as the lure of profitability has allowed it to become a primary source of funding for many startups. This, in turn, has fostered innovation which translates into economic growth.

What Is an Allowance for Doubtful Accounts?

An allowance for doubtful accounts is a contra account that nets against the total receivables presented on the balance sheet to reflect only the amounts expected to be paid. The allowance for doubtful accounts estimates the percentage of accounts receivable that are expected to be uncollectible. However, the actual payment behavior of customers may differ substantially from the estimate.

Understanding the Allowance for Doubtful Accounts

Regardless of company policies and procedures for credit collections, the risk of the failure to receive payment is always present in a transaction utilizing credit. Thus, a company is required to realize this risk through the establishment of the allowance for doubtful accounts and offsetting bad debt expense. In accordance with the matching principle of accounting, this ensures that expenses related to the sale are recorded in the same accounting period as the revenue is earned. The allowance for doubtful accounts also helps companies more accurately estimate the actual value of their account receivables.

Because the allowance for doubtful accounts is established in the same accounting period as the original sale, an entity does not know for certain which exact receivables will be paid and which will default. Therefore, generally accepted accounting principles (GAAP) dictate that the allowance must be established in the same accounting period as the sale, but can be based on an anticipated or estimated figure. The allowance can accumulate across accounting periods and may be adjusted based on the balance in the account.

How to Estimate the Allowance for Doubtful Accounts

Two primary methods exist for estimating the dollar amount of accounts receivables not expected to be collected.

Percentage of Sales Method

The sales method applies a flat percentage to the total dollar amount of sales for the period. For example, based on previous experience, a company may expect that 3% of net sales are not collectible. If the total net sales for the period is $100,000, the company establishes an allowance for doubtful accounts for $3,000 while simultaneously reporting $3,000 in bad debt expense.

If the following accounting period results in net sales of $80,000, an additional $2,400 is reported in the allowance for doubtful accounts, and $2,400 is recorded in the second period in bad debt expense. The aggregate balance in the allowance for doubtful accounts after these two periods is $5,400.

Accounts Receivable Aging Method

The second method of estimating the allowance for doubtful accounts is the aging method. All outstanding accounts receivable are grouped by age, and specific percentages are applied to each group. The aggregate of all group results is the estimated uncollectible amount.

For example, a company has $70,000 of accounts receivable less than 30 days outstanding and $30,000 of accounts receivable more than 30 days outstanding. Based on previous experience, 1% of accounts receivable less than 30 days old will be uncollectible, and 4% of those accounts receivable at least 30 days old will be uncollectible.

Therefore, the company will report an allowance of $1,900 (($70,000 * 1%) + ($30,000 * 4%)). If the next accounting period results in an estimated allowance of $2,500 based on outstanding accounts receivable, only $600 ($2,500 – $1,900) will be the adjusting entry amount.

Risk Classification Method

Some companies may classify different types of debt or different types of vendors using risk classifications. For example, a start-up customer may be considered a high risk, while an established, long-tenured customer may be a low risk. In this example, the company often assigns a percentage to each classification of debt. Then, it aggregates all receivables in each grouping, calculates each group by the percentage, and records an allowance equal to the aggregate of all products.

Historical Percentage Method

If a company has a history of recording or tracking bad debt, it can use the historical percentage of bad debt if it feels that historical measurement relates to its current debt. For example, a company may know that its 10-year average of bad debt is 2.4%. Therefore, it can assign this fixed percentage to its total accounts receivable balance since more often than not, it will approximately be close to this amount. The company must be aware of outliers or special circumstances that may have unfairly impacted that 2.4% calculation.

Pareto Analysis Method

A Pareto analysis is a risk measurement approach that states that a majority of activity is often concentrated among a small amount of accounts. In many different aspects of business, a rough estimation is that 80% of account receivable balances are made up of a small concentration (i.e. 20%) of vendors. This 80%/20% ratio is used throughout business.

Though the Pareto Analysis can not be used on its own, it can be used to weigh accounts receivable estimates differently. For example, a company may assign a heavier weight to the clients that make up a larger balance of accounts receivable due to conservatism.

Specific Identification Method

Assume a company has 100 clients and believes there are 11 accounts that may go uncollected. Instead of applying percentages or weights, it may simply aggregate the account balance for all 11 customers and use that figure as the allowance amount. Companies often have a specific method of identifying the companies that it wants to include and the companies it wants to exclude.

How to Account for the Allowance for Doubtful Accounts

Establishing the Allowance

The first step in accounting for the allowance for doubtful accounts is to establish the allowance. This is done by using one of the estimation methods above to predict what proportion of accounts receivable will go uncollected. For this example, let’s say a company predicts it will incur $500,000 of uncollected accounts receivable.

To create the allowance, the company must debit a loss. Most often, companies use an account called ‘Bad Debt Expense’. Then, the company establishes the allowance by crediting an allowance account often called ‘Allowance for Doubtful Accounts’. Though this allowance for doubtful accounts is presented on the balance sheet with other assets, it is a contra asset that reduces the balance of total assets.

• DR Bad Debt Expense $500,000
• CR Allowance for Doubtful Accounts $500,000

Adjusting the Allowance

Let’s say six months passes. The company now has a better idea of which account receivables will be collected and which will be lost. For example, say the company now thinks that a total of $600,000 of receivables will be lost. This means its allowance of $500,000 is $100,000 short. The company must record an additional expense for this amount to also increase the allowance’s credit balance.

• DR Bad Debt Expense $100,000
• CR Allowance for Doubtful Accounts $100,000

Writing Off Account

Now, let’s say a specific customer that owes a company $50,000 officially files for bankruptcy. This client’s account had previously been included in the estimate for the allowance. Because the company has a very low priority claim without collateral to the debt, the company decides it is unlikely it will every receive any of this $50,000. To properly reflect this change, the company must reduce its accounts receivable balance by this amount. On the other hand, once the receivable is removed from the books, there is no need to record an associated allowance for this account.

• DR Allowance for Doubtful Accounts $50,000
• CR Accounts Receivable $50,000

Note that the debit to the allowance for doubtful accounts reduces the balance in this account because contra assets have a natural credit balance. Also, note that when writing off the specific account, no income statement accounts are used. This is because the expense was already taken when creating or adjusting the allowance.

Recovering an Account

By miracle, it turns out the company ended up being rewarded a portion of their outstanding receivable balance they’d written off as part of the bankruptcy proceedings. Of the $50,000 balance that was written off, the company is notified that they will receive $35,000.

The company can recover the account by reversing the entry above to reinstate the accounts receivable balance and the corresponding allowance for doubtful account balance. Then, the company will record a debit to cash and credit to accounts receivable when the payment is collected. You’ll notice that because of this, the allowance for doubtful accounts increases. A company can further adjust the balance by following the entry under the “Adjusting the Allowance” section above.

• DR Accounts Receivable $35,000
• CR Allowance for Doubtful Accounts $35,000
• DR Cash $35,000
• CR Accounts Receivable $35,000

The Bottom Line

The allowance for doubtful accounts is a general ledger account that is used to estimate the amount of accounts receivable that will not be collected. A company uses this account to record how many accounts receivable it thinks will be lost. The balance may be estimated using several different methods, and management should periodically evaluate the balance of the allowance account to ensure the appropriate bad debt expense and net accounts receivables are being recorded.

What Is Accrued Interest?

In accounting, accrued interest refers to the amount of interest that has been incurred, as of a specific date, on a loan or other financial obligation but has not yet been paid out. Accrued interest can either be in the form of accrued interest revenue, for the lender, or accrued interest expense, for the borrower.

The term accrued interest also refers to the amount of bond interest that has accumulated since the last time a bond interest payment was made.

Understanding Accrued Interest

Accrued interest is calculated as of the last day of the accounting period. For example, assume interest is payable on the 20th of each month, and the accounting period is the end of each calendar month. The month of April will require an accrual of 10 days of interest, from the 21st to the 30th. It is posted as part of the adjusting journal entries at month-end.

Accrued interest is reported on the income statement as a revenue or expense, depending on whether the company is lending or borrowing. In addition, the portion of revenue or expense yet to be paid or collected is reported on the balance sheet as an asset or liability. Because accrued interest is expected to be received or paid within one year, it is often classified as a current asset or current liability.

Accrual Accounting and Accrued Interest

Accrued interest is a result of accrual accounting, which requires that accounting transactions be recognized and recorded when they occur, regardless of whether payment has been received or expended at that time. The ultimate goal when accruing interest is to ensure that the transaction is accurately recorded in the right period. Accrual accounting differs from cash accounting, which recognizes an event when cash or other forms of consideration trade hands.

The revenue recognition principle and matching principle are both important aspects of accrual accounting, and both are relevant in the concept of accrued interest. The revenue recognition principle states that revenue should be recognized in the period in which it was earned, rather than when payment is received. The matching principle states that expenses should be recorded in the same accounting period as the related revenues.

To illustrate how these principles impact accrued interest, consider a business that takes out a loan to purchase a company vehicle. The company owes the bank interest on the vehicle on the first day of the following month. The company has use of the vehicle for the entire prior month, and is, therefore, able to use the vehicle to conduct business and generate revenue.

At the end of each month, the business will need to record interest that it expects to pay out on the following day. In addition, the bank will be recording accrued interest income for the same one-month period because it anticipates the borrower will be paying it the following day.

Accrued Interest Example – Accounting

Consider the following example. Let us assume there is a $20,000 loan receivable with an interest rate of 7.5%, on which payment has been received for the period through the 20th day of the month. In this scenario, to record the extra amount of interest revenue that was earned from the 21st to the 30th of the month, the calculation would be as follows:

• (7.5% x (10 / 365)) x $20,000 = $41.10

The amount of accrued interest for the party who is receiving payment is a credit to the interest revenue account and a debit to the interest receivable account. The receivable is consequently rolled onto the balance sheet and classified as a short-term asset. The same amount is also classified as revenue on the income statement.

The accrued interest for the party who owes the payment is a credit to the accrued liabilities account and a debit to the interest expense account. The liability is rolled onto the balance sheet as a short-term liability, while the interest expense is presented on the income statement.

Both cases are posted as reversing entries, meaning that they are subsequently reversed on the first day of the following month. This ensures that when the cash transaction occurs in the following month, the net effect is only the portion of the revenue or expense that was earned or incurred in the current period stays in the current period.

Using the example above, $123.29 (7.5% x (30/365) x $20,000) is received by the lending company on the 20th day of the second month. Of that, $41.10 related to the prior month and was booked as an adjusting journal entry at the prior month end to recognize the revenue in the month it was earned. Because the adjusting journal entry reverses in the second month, the net effect is that $82.19 ($123.29 – $41.10) of the payment is recognized in the second month. That is equivalent to the 20 days worth of interest in the second month.

Accrued Interest Example – Bonds

Accrued interest is an important consideration when purchasing or selling a bond. Bonds offer the owner compensation for the money they have lent, in the form of regular interest payments. These interest payments, also referred to as coupons, are generally paid semiannually.

If a bond is bought or sold at a time other than those two dates each year, the purchaser will have to tack onto the sales amount any interest accrued since the previous interest payment. The new owner will receive a full 1/2 year interest payment at the next payment date. Therefore, the previous owner must be paid the interest that accrued prior to the sale.

Let’s assume you are interested in buying a bond with a face value of $1,000 and a 5% semiannual coupon. The interest payment is made twice a year on June 1 and December 1 and you plan to buy the bond on September 30. How much accrued interest would you have to pay?

Bond markets use a number of slightly differing day-count conventions to calculate the exact amount of accrued interest. Since most U.S. corporate and municipal bonds use the 30/360 convention, which assumes that each month has 30 days (regardless of the actual number of days in a particular month), we will use that day-count convention in this example.

Step 1: Calculate the exact number of days between the date of the last coupon payment (June 1) and your purchase date (September 30). In this example, the number of days (based on the 30/360 convention) is 120 days.

Step 2: Calculate accrued interest by multiplying the day count by the daily interest rate and face value of the bond.

Thus, accrued interest = 120 x (5% / 360) * $1,000 = $16.67

Step 3: Add the accrued interest to the face value of the bond to get your purchase price.

Purchase price of bond = $1,000 + $16.67 = $1,016.67

On the next coupon payment date (December 1), you will receive $25 in interest. But since you paid $16.67 in accrued interest when you purchased the bond, the net interest received by you is $8.33 ($25 – $16.67), which is precisely the amount of interest you should have received for the 60 days that you owned the bond until the next coupon payment (September 30 to December 1).

What Is Activity-Based Management?

Activity-based management (ABM) is a system for determining the profitability of every aspect of a business so that its strengths can be enhanced and its weaknesses can either be improved or eliminated altogether.

Activity-based management (ABM), which was first developed in the 1980s, seeks to highlight the areas where a business is losing money so that those activities can be eliminated or improved to increase profitability. ABM analyzes the costs of employees, equipment, facilities, distribution, overhead, and other factors in business to determine and allocate activity costs.

Understanding Activity-Based Management (ABM)

Activity-based management can be applied to different types of companies, including manufacturers, service providers, non-profits, schools, and government agencies. ABM can provide cost information about any area of operations in a business.

In addition to improving profitability and the overall financial strength of a company, the results of an ABM analysis can help that company produce more accurate budgets and long-term financial forecasts.

Examples of Activity-Based Management (ABM)

ABM can be used, for example, to analyze the profitability of a new product a company is offering, by looking at marketing and production costs, sales, warranty claims, and any costs or repair time needed for returned or exchanged products. If a company is reliant on a research and development department, ABM can be used to look at the costs of operating the department, the costs of testing out new products and whether the products developed there turned out to be profitable.

Another example might be a company that has opened an office in a second location. ABM can help management assess the costs of the running that location, including the staff, facilities, and overhead, and then determine whether any subsequent profits are enough to make up for or justify those costs.

Special Considerations

A lot of the information gathered in activity-based management is derived from information gathered from another management tool, activity-based costing (ABC). Whereas activity-based management focuses on business processes and managerial activities driving organizational business goals, activity-based costing seeks to identify and reduce cost drivers by optimizing resources.

Both ABC and ABM are management tools that help in managing operational activities to improve the performance of a business entity or an entire organization.

Activity-based costing can be considered an offshoot of activity-based management. By mapping business costs like supplies, salaries, and leasing activity to business processes, products, customers, and distribution activity, activity-based costing helps improve overall managerial effectiveness and transparency.