Net realizable value (NRV) is an accounting term that is used in two different ways. The first refers to a method of establishing the value of goods held in inventory for the purpose of accounting statements. When valuing inventory, businesses must be careful to avoid understating or overstating value, as this would cause distortions on financial accounts. The other meaning of this word is related to calculating the value of accounts receivable.
In the context of inventory, net realizable value is the amount of money that would be realized from a sale, minus the expenses associated with completing the sale. These expenses can include marketing, storage in inventory, and other costs. Another way of looking at the value of goods in inventory is to value them by the cost to the company. When preparing statements, companies must select the lower value to avoid overstatements of the value of their inventory that might mislead people examining those statements.
Net realizable value can be higher than cost. If inventories were valued solely using this metric, it would create an artificially inflated assessment of the value of the inventory. Calculations of net realizable value assume the best possible cost at time of sale, for instance, and may not accurately reflect how much a good in inventory really will sell for. On the other hand, if product costs are unusually high, valuing inventory by cost to the company can also create a skewed picture.
In the case of accounts receivable, the net realizable value reflects the amount of accounts outstanding that are likely to be converted into cash. This number is determined by listing all of the accounts receivable and subtracting non-collectible accounts. Removing non-collectible accounts is done to avoid an artificially high number and provide a more realistic assessment of how much a company can expect to collect from accounts receivable in a given accounting period.
The meaning intended when this term is used is usually clear from the context. Financial statements that use net realizable value will show inventory and accounts receivable in different areas, making the distinction clear. Companies can also show the math they used to calculate the net realizable value if there are concerns that the value is not stated correctly or there are questions about how companies define non-collectible accounts and costs associated with completing sales. Learning to read financial statements and understand the terms used is important for people such as investors.
