What Is an Accredited Investor?

An accredited investor is an individual or a business entity that is allowed to trade securities that may not be registered with financial authorities. They are entitled to this privileged access by satisfying at least one requirement regarding their income, net worth, asset size, governance status, or professional experience.

In the U.S., the term accredited investor is used by the Securities and Exchange Commission (SEC) under Regulation D to refer to investors who are financially sophisticated and have a reduced need for the protection provided by regulatory disclosure filings. Accredited investors include high-net-worth individuals (HNWIs), banks, insurance companies, brokers, and trusts.

Understanding Accredited Investors

Accredited investors are legally authorized to purchase securities that are not registered with regulatory authorities like the SEC. Many companies decide to offer securities to this class of accredited investors directly. Because this decision allows companies exemption from registering securities with the SEC, it can save them a lot of money.

This type of share offering is referred to as a private placement. It has the potential to present these accredited investors with a great deal of risk. Therefore authorities need to ensure that they are financially stable, experienced, and knowledgeable about their risky ventures.

When companies decide to offer their shares to accredited investors, the role of regulatory authorities is limited to verifying or offering the necessary guidelines for setting benchmarks to determine who qualifies as an accredited investor. Regulatory authorities help determine if the applicant possesses the necessary financial means and knowledge to take the risks involved in investing in unregistered securities.

Accredited investors also have privileged access to venture capital, hedge funds, angel investments, and deals involving complex and higher-risk investments and instruments.

Requirements for Accredited Investors

The regulations for accredited investors vary from one jurisdiction to the other and are often defined by a local market regulator or a competent authority. In the U.S, the definition of an accredited investor is put forth by SEC in Rule 501 of Regulation D.

To be an accredited investor, a person must have an annual income exceeding $200,000 ($300,000 for joint income) for the last two years with the expectation of earning the same or a higher income in the current year. An individual must have earned income above the thresholds either alone or with a spouse over the last two years. The income test cannot be satisfied by showing one year of an individual’s income and the next two years of joint income with a spouse.

A person is also considered an accredited investor if they have a net worth exceeding $1 million, either individually or jointly with their spouse. This amount cannot include a primary residence. The SEC also considers a person to be an accredited investor if they are a general partner, executive officer, or director for the company that is issuing the unregistered securities.

An entity is considered an accredited investor if it is a private business development company or an organization with assets exceeding $5 million. Also, if an entity consists of equity owners who are accredited investors, the entity itself is an accredited investor. However, an organization cannot be formed with the sole purpose of purchasing specific securities.

Recent Changes to the Accredited Investor Definition

Recently, the U.S. Congress modified the definition of an accredited investor to include registered brokers and investment advisors.

On Aug. 26, 2020, the U.S. Securities and Exchange Commission amended the definition of an accredited investor. According to the SEC’s press release, “the amendments allow investors to qualify as accredited investors based on defined measures of professional knowledge, experience or certifications in addition to the existing tests for income or net worth. The amendments also expand the list of entities that may qualify as accredited investors, including by allowing any entity that meets an investments test to qualify.”

Among other categories, the SEC now defines accredited investors to include the following: individuals who have certain professional certifications, designations, or credentials; individuals who are “knowledgeable employees” of a private fund; and SEC- and state-registered investment advisors.

Purpose of Accredited Investor Requirements 

Any regulatory authority of a market is tasked with both promoting investment and safeguarding investors. On one hand, regulators have a vested interest in promoting investments in risky ventures and entrepreneurial activities because they have the potential to emerge as multi-baggers in the future. Such initiatives are risky, may be focused on concept-only research and development activities without any marketable product, and may have a high chance of failure. If these ventures are successful, they offer a big return to their investors. However, they also have a high probability of failure.

On the other hand, regulators need to protect less-knowledgeable, individual investors who may not have the financial cushion to absorb high losses or understand the risks associated with their investments. Therefore, the provision of accredited investors allows access for both investors who are financially well-equipped, as well as investors who are knowledgeable and experienced.

There is no formal process for becoming an accredited investor. Rather, it is the responsibility of the sellers of such securities to take a number of different steps in order to verify the status of entities or individuals who wish to be treated as accredited investors. 

Individuals or parties who want to be accredited investors can approach the issuer of the unregistered securities. The issuer may ask the applicant to respond to a questionnaire to determine if the applicant qualifies as an accredited investor. The questionnaire may require various attachments: account information, financial statements, and a balance sheet to verify the qualification. The list of attachments can extend to tax returns, W-2 forms, salary slips, and even letters from reviews by CPAs, tax attorneys, investment brokers, or advisors. Additionally, the issuers may also evaluate an individual’s credit report for additional assessment.

Example of an Accredited Investor

For example, suppose there is an individual whose income was $150,000 for the last three years. They reported a primary residence value of $1 million (with a mortgage of $200,000), a car worth $100,000 (with an outstanding loan of $50,000), a 401(k) account with $500,000, and a savings account with $450,000. While this individual fails the income test, they are an accredited investor according to the test on net worth, which cannot include the value of an individual’s primary residence. Net worth is calculated as assets minus liabilities.

This person’s net worth is exactly $1 million. This involves a calculation of their assets (other than their primary residence) of $1,050,000 ($100,000 + $500,000 + $450,000) less a car loan equaling $50,000. Since they meet the net worth requirement, they qualify to be an accredited investor.

The Bottom Line

The accredited investor rules are designed to protect potential investors with limited financial knowledge from risky ventures and losses they may be ill equipped to withstand. But on the flip side, it gives people already starting off with large financial assets a major advantage over those with more modest assets.

What Are Accounts Receivable (AR)?

Accounts receivable (AR) are the balance of money due to a firm for goods or services delivered or used but not yet paid for by customers. Accounts receivable are listed on the balance sheet as a current asset. Any amount of money owed by customers for purchases made on credit is AR.

Understanding Accounts Receivable

Accounts receivable refer to the outstanding invoices that a company has or the money that clients owe the company. The phrase refers to accounts that a business has the right to receive because it has delivered a product or service. Accounts receivable, or receivables, represent a line of credit extended by a company and normally have terms that require payments due within a relatively short period. It typically ranges from a few days to a fiscal or calendar year.

Companies record accounts receivable as assets on their balance sheets because there is a legal obligation for the customer to pay the debt. They are considered a liquid asset, because they can be used as collateral to secure a loan to help meet short-term obligations. Receivables are part of a company’s working capital.

Furthermore, accounts receivable are current assets, meaning that the account balance is due from the debtor in one year or less. If a company has receivables, this means that it has made a sale on credit but has yet to collect the money from the purchaser. Essentially, the company has accepted a short-term IOU from its client.

Accounts Receivable vs. Accounts Payable

When a company owes debts to its suppliers or other parties, these are accounts payable. Accounts payable are the opposite of accounts receivable. To illustrate, imagine Company A cleans Company B’s carpets and sends a bill for the services. Company B owes them money, so it records the invoice in its accounts payable column. Company A is waiting to receive the money, so it records the bill in its accounts receivable column.

Benefits of Accounts Receivable

Accounts receivable are an important aspect of a business’s fundamental analysis. Accounts receivable are a current asset, so it measures a company’s liquidity or ability to cover short-term obligations without additional cash flows. 

Fundamental analysts often evaluate accounts receivable in the context of turnover, also known as accounts receivable turnover ratio, which measures the number of times a company has collected on its accounts receivable balance during an accounting period. Further analysis would include assessing days sales outstanding (DSO), the average number of days that it takes to collect payment after a sale has been made.

Example of Accounts Receivable

An example of accounts receivable includes an electric company that bills its clients after the clients received the electricity. The electric company records an account receivable for unpaid invoices as it waits for its customers to pay their bills. 

Most companies operate by allowing a portion of their sales to be on credit. Sometimes, businesses offer this credit to frequent or special customers that receive periodic invoices. The practice allows customers to avoid the hassle of physically making payments as each transaction occurs. In other cases, businesses routinely offer all of their clients the ability to pay after receiving the service.

What Are Accounts Payable (AP)?

Accounts payable (AP), or “payables,” refer to a company’s short-term obligations owed to its creditors or suppliers, which have not yet been paid. Payables appear on a company’s balance sheet as a current liability.

Another, less common usage of “AP,” refers to the business department or division that is responsible for making payments owed by the company to suppliers and other creditors.

Accounts payable can be compared with accounts receivable.

Understanding Accounts Payable (AP)

A company’s total accounts payable balance at a specific point in time will appear on its balance sheet under the current liabilities section. Accounts payable are obligations that must be paid off within a given period to avoid default. At the corporate level, AP refers to short-term payments due to suppliers. The payable is essentially a short-term IOU from one business to another business or entity. The other party would record the transaction as an increase to its accounts receivable in the same amount.

AP is an important figure in a company’s balance sheet. If AP increases over a prior period, that means the company is buying more goods or services on credit, rather than paying cash. If a company’s AP decreases, it means the company is paying on its prior period obligations at a faster rate than it is purchasing new items on credit. Accounts payable management is critical in managing a business’s cash flow.

When using the indirect method to prepare the cash flow statement, the net increase or decrease in AP from the prior period appears in the top section, the cash flow from operating activities. Management can use AP to manipulate the company’s cash flow to a certain extent. For example, if management wants to increase cash reserves for a certain period, they can extend the time the business takes to pay all outstanding accounts in AP.

However, this flexibility to pay later must be weighed against the ongoing relationships the company has with its vendors. It’s always good business practice to pay bills by their due dates.

Recording Accounts Payable

Proper double-entry bookkeeping requires that there must always be an offsetting debit and credit for all entries made into the general ledger. To record accounts payable, the accountant credits accounts payable when the bill or invoice is received. The debit offset for this entry generally goes to an expense account for the good or service that was purchased on credit. The debit could also be to an asset account if the item purchased was a capitalizable asset. When the bill is paid, the accountant debits accounts payable to decrease the liability balance. The offsetting credit is made to the cash account, which also decreases the cash balance.

For example, imagine a business gets a $500 invoice for office supplies. When the AP department receives the invoice, it records a $500 credit in accounts payable and a $500 debit to office supply expense. The $500 debit to office supply expense flows through to the income statement at this point, so the company has recorded the purchase transaction even though cash has not been paid out. This is in line with accrual accounting, where expenses are recognized when incurred rather than when cash changes hands. The company then pays the bill, and the accountant enters a $500 credit to the cash account and a debit for $500 to accounts payable.

A company may have many open payments due to vendors at any one time. All outstanding payments due to vendors are recorded in accounts payable. As a result, if anyone looks at the balance in accounts payable, they will see the total amount the business owes all of its vendors and short-term lenders. This total amount appears on the balance sheet. For example, if the business above also received an invoice for lawn care services in the amount of $50, the total of both entries in accounts payable would equal $550 prior to the company paying off those obligations.

Accounts Payable vs. Trade Payables

Although some people use the phrases “accounts payable” and “trade payables” interchangeably, the phrases refer to similar but slightly different situations. Trade payables constitute the money a company owes its vendors for inventory-related goods, such as business supplies or materials that are part of the inventory. Accounts payable include all of the company’s short-term obligations.

For example, if a restaurant owes money to a food or beverage company, those items are part of the inventory, and thus part of its trade payables. Meanwhile, obligations to other companies, such as the company that cleans the restaurant’s staff uniforms, fall into the accounts payable category. Both of these categories fall under the broader accounts payable category, and many companies combine both under the term accounts payable.

Accounts Payable vs. Accounts Receivable

Accounts receivable (AR) and accounts payable are essentially opposites. Accounts payable is the money a company owes its vendors, while accounts receivable is the money that is owed to the company, typically by customers. When one company transacts with another on credit, one will record an entry to accounts payable on their books while the other records an entry to accounts receivable.

The Bottom Line

Accounts payable (AP) refer to the obligations incurred by a company during its operations that remain due and must be paid in the short term. As such, AP is listed on the balance sheet as a current liability. Typical payables items include supplier invoices, legal fees, contractor payments, and so on.

What Is an Accounting Method?

An accounting method refers to the rules a company follows in reporting revenues and expenses. The two primary methods of accounting are accrual accounting (generally used by companies) and cash accounting (generally used by individuals).

Cash accounting reports revenues and expenses as they are received and paid through cash inflows and outflows; accrual accounting reports them as they are earned and incurred through sales and purchases on credit and by using accounts receivable & accounts payable. Generally accepted accounting principles (GAAP) requires accrual accounting.

Understanding an Accounting Method

All businesses need to keep accounting records. Public companies are required to do so. Accounting allows a business to monitor every aspect of its finances, from revenues to costs to taxes and more. Without accurate accounting, a business would not know where it stood financially, most likely resulting in its demise.

Accounting is also needed to pay accurate taxes to the Internal Revenue Service (IRS). If the IRS ever conducts an audit on a company, it looks at a company’s accounting records and methods. Furthermore, the IRS requires taxpayers to choose an accounting method that accurately reflects their income and to be consistent in their choice of accounting method from year to year.

This is because switching between methods would potentially allow a company to manipulate revenue to minimize their tax burdens. As such, IRS approval is required to change methods. Companies may use a hybrid of the two methods, which is allowable under IRS rules if specified requirements are met.

Types of Accounting Methods

Cash Accounting

Cash accounting is an accounting method that is relatively simple and is commonly used by small businesses. In cash accounting, transactions are only recorded when cash is spent or received.

In cash accounting, a sale is recorded when the payment is received and an expense is recorded only when a bill is paid. The cash accounting method is, of course, the method most people use in managing their personal finances and it is appropriate for businesses up to a certain size.

If a business generates more than $25 million in average annual gross receipts for the preceding three years, however, it must use the accrual method, according to Internal Revenue Service rules.

Accrual Accounting

Accrual accounting is based on the matching principle, which is intended to match the timing of revenue and expense recognition. By matching revenues with expenses, the accrual method gives a more accurate picture of a company’s true financial condition.

Under the accrual method, transactions are recorded when they are incurred rather than awaiting payment. This means a purchase order is recorded as revenue even though the funds are not received immediately. The same goes for expenses in that they are recorded even though no payment has been made.

Example of an Accounting Method

The value of accrual accounting becomes more evident for large, complex businesses. A construction company, for example, may undertake a long-term project and may not receive complete cash payments until the project is complete.

Under cash accounting rules, the company would incur many expenses but would not recognize revenue until cash was received from the customer. So, the accounting book of the company would look weak until the revenue actually came in. If this company was looking for debt financing from a bank, for example, the cash accounting method makes it look like a poor bet because it is incurring expenses but no revenue.

Under accrual accounting, the construction company would recognize a percentage of revenue and expenses corresponding to the portion of the project that was complete. This is known as the percentage of completion method. How much actual cash coming into the company, however, would be evident in the cash flow statement. This method would show a prospective lender a much more complete and accurate picture of the company’s revenue pipeline.