Businesses must report their assets at the real value when they prepare financial statements not in exaggerated figures. In this regard, Net Realizable Value (NRV) is essential since it will make sure that your inventory and receivables is valued fairly, considering the cost incurred to sell or complete it.
In the case of SMEs, it is necessary to learn to value and compute NRV in order to not overstate profits and present financial health negatively. We will discuss the net realizable value formula in this guide, decompose it using simple examples, underscore the common pitfalls, and demonstrate how the cloud-based accounting software of FastLane HR can make the task less cumbersome.
What is Net Realizable Value (NRV)?
The estimated selling price of an asset in the normal course of business is known as Net Realizable Value (NRV) without any reference to the cost incurred to complete and sell the asset.
It is based on the lower of cost or market principle which act to require businesses to record the inventory or receivables at the lower of the original cost or the NAV.
Summing up, NRV make sure that your financial records represent a fair image of your company assets.
Why is NRV Important for SMEs?
There is often a small margin on which SMEs operate, and as such, valuation is important. Here’s why NRV is important:
- Makes sure that inventory is worth what it is.
- Assists in identifying the possible losses at an early stage.
- establishes investor, lender and stakeholder trust.
- Makes your business IFRS and GAAP accounting compliant.
Financial statements that are not adjusted by NRV can be misleading to the decision-makers and detrimental to long-term planning.
Net Realizable Value Formula
The equation is simple:
NRV = Estimated Selling Price – Costs of Completion – Selling Costs
Estimated Selling Price: This is the price you are expected to sell the asset.
Costs of Completion: Production expenses to complete manufacturing, or get ready to sell (e.g. packaging).
Selling Costs: This is the extra expenses to sell (e.g., freight, commissions, advertising).
Calculation of Net Realizable Value Step-by-Step
- Determine the selling price of the inventory or receivable.
- Determine the amount of money necessary to finish it or sell it.
- These costs should be deducted to the selling price.
- Enter the last figure in books.
This is to make sure that you do not overstate your assets on the balance sheet.
Net Realizable Value Example
1: Inventory
- Expected selling price: $10,000
- Costs of completion: $1,500
- Selling costs: $500
NRV = 10,000 – 1,500 – 500 = $8,000
This implies that the inventory should be valued at 8000 dollars.
2: Accounts Receivable
- Customer balance: $5,000
- Uncollectible amount expected: $500.
NRV = 5,000 – 500 = $4,500
In your financial statements, the receivable, therefore, should be worth 4,500.
The SMEs mistakes commonly make in NRV
Most SMEs have problems with NRV due to:
- Excessive selling prices.
- No consideration to selling or completion costs.
- Leaving to forget writing down old or damaged inventory.
- Failure to update NRV following the change in market conditions.
These errors have the potential to overvalue assets hence giving false financial reporting.
How Cloud-Based Accounting Software Make NRV Calculations Easy
Calculations of NRV can be complex and subject to errors in manuals. Using cloud based accounting software, SMEs are able to:
- Automate inventory change of value.
- Monitor the receivables in real-time and minimize errors.
- Create real-time financial reports to the stakeholders.
- Remain non-stressful with accounting standards.
FastLane HR uses cloud-based solutions to make the management of NRV simple in the SMEs at FastLane- save time, minimise errors, and be sure of your figures.
Questions and answers on Net Realizable Value
Fair value is the market price; NRV is the selling price less expenditure.
At least once every accounting period, or more often in case of a change of market conditions.
No, it is also applicable in accounts receivable.
Yes–this process can be done in a great deal by cloud-based systems such as those of FastLane HR.
Conclusion
The net realizable value formula will also make sure that SMEs maintain the records of inventory and receivables with appropriate values and costs. You can see the true picture of the financial position of your business, through clear calculations that prevent over-stating of assets, ensure compliance and have a clear picture.
However, they are time-consuming and can be erroneous when done manually. The cloud-based accounting software by FastLane HR is more than welcome there, and it will automate the changes of NRV and provide peace of mind to SMEs.
Are you planning to make accounting easier?
Contact FastLane HR and learn how our cloud-based solutions will help you calculate NRV with ease.