Fair value is a general term describing the value of an asset if it were sold on an open market, while net realizable value is a term specific to evaluating accounts receivable and inventory in context of related expenses and losses. While both are estimates of an asset’s value, net present value better represents how much a business will profit on a transaction, while fair value describes what revenue a business will generate by selling a good.
The fair value of an asset is the amount of money you would get if you sold the good in the current market. Fair value assumes that the good is sold by one party to an unaffiliated buyer, and that the seller is not under any duress or pressure to raise cash. This assumption is important, because it presumes that in those circumstances the seller would be able to get the highest price possible for his good.
Net Realizable Value – Accounts Receivable
Net Realizable Value (NRV) pertains to two different aspects of valuing business assets. Accounts receivable are amounts that a business is owed by its customers for goods or services provided on credit. The NRV of this asset is how much the business can expect to collect on the amount due. The NPV in this case is the amount owed minus the allowance for doubtful accounts. The allowance for doubtful accounts is a balance maintained to offset accounts receivable and is an estimate of how much of accounts receivable will not be collected at any given time. This estimate is based on past defaults by customers.
Net Realizable Value – Inventory
NRV as applied to inventory has a slightly different connotation. The inventory of a manufacturer rarely consists of just completed products. Inventory will contain the raw materials to make the goods as well as products that are in the process of being made but are not completed. NRV for inventory is the estimated selling price, or fair value, of the inventory once it has all been manufactured into finish products, minus the costs to finish and sell the goods.
When preparing financial statements, consult with a certified public accountant to ensure that everything is done according to the appropriate accounting guidelines. This article does not provide legal advice; it is for educational purposes only. Use of this article does not create any attorney-client relationship.
John Cromwell specializes in financial, legal and small business issues. Cromwell holds a bachelor's and master's degree in accounting, as well as a Juris Doctor. He is currently a co-founder of two businesses.