Inventory Shrinkage: Definition, Causes & How to Prevent It

Cody Cromwell
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What Is Inventory Shrinkage?

Inventory shrinkage is when the amount of product in your supply chain turns out not to be in line with what is listed in your inventory records. It’s a significant cost for manufacturers and can be somewhat of a mystery.

While a factory can have a close eye on a lot of the product coming into and going out of the building, there are a lot of other parts that certain factories only have a partial view on. For example, if the plant doesn’t have a window to the warehouse, there’s no way to know exactly what’s going on with the goods. As a result, it’s almost impossible to control everything that happens in the supply chain and guarantees some form of inventory shrinkage.

Another issue with inventory shrinkage is that it can be difficult to detect specifically. Since it’s not an immediate consequence that the actual amount of product in your facility is lower than what is listed in your inventory records, the issue might not come to your attention until you’re forced to write off a particular product that you have low on stock. Great care should be taken to avoid keeping too much product in inventory.

During stock outs, these three scenarios can happen:

How to Calculate Inventory Shrinkage

Inventory shrinkage is the amount of money lost due to a dishonest or unprofessional employee. The value of every item is listed on the warranty or paperwork that comes with the purchase. When you receive the product, it should match this list.

The amount of savings your business can achieve is simply the difference between the amount paid for the product and the amount paid for the product at clearance date. The reason we calculate this is because it’s impossible to track how much product is sold or how much is used. You may also be wondering why the employee took a product from the shelf and did not return it to the shelf. The only way to catch this problem could be by using a camera system.

While no employee will admit to stealing from the workplace, the chance of that happening is slim. However, if the customer is not made aware of this product shrinkage, they may never return to your store.

If the product is not on the shelf for all customers to purchase, there is a chance that they will purchase your competitor’s product. If the goal of your store is to offer your customers the best product at the lowest price, then you need to be cognizant of the product you are selling. When you lose money due to shrinkage, you are stealing from your wallet as well as your profits.

What Causes Inventory Shrinkage?

The makeup of inventory at the end of the day depends on a lot of factors, including which products were on sale, what discounts you offered and how long it took customers to pick up their purchases.

To get a better understanding of the factors that may affect your inventory shrinkage, let’s take a look at how inventory is valued, sorted and put on the sales floor right after you’ve counted it.

Most inventory is purchased without a specified value. This is because brand names, types and quantities are variable. So it’s very hard to put a price tag on certain inventory, such as toys, housewares and seasonal items.

To get a more accurate count of inventory, it’s best to check the month’s sales and walk through the store looking at all the in-stock items to get a better idea of what’s actually in the store. Or, count inventory as best you can upon arrival. Get accurate counts on the busiest days and compare it to the sales reports. You’ll know exactly how your inventory’s provenance was influenced by sales and promotions.

Retail Shrink Due to Customer Theft

Shrinkage is a concept that can be applied to any business, including retail. Shrinkage can occur when a product is erroneously put into a single bin or bin set, then goes missing. While effective and highly accessible bin sets can reduce shrinkage in retail, those who don’t use them can experience up to 50 percent of shrinkage.

This is due to the fact that some customers are more inclined to steal parts over weeks, months or even years. This is a problem which can be prevented by implementing an effective inventory shrink control system in your retail business.

Retail Shrink Due to Employee Theft

Retailers who offer products from multiple vendors often encounter inventory shrinkage, which can come from any entity working in the supply chain. In retail, inventory shrinkage often due to employee theft or by returning products. In the case of employee theft, employees who steal products from the store are less likely to blame the company and more likely promote their own honor/reputation. Therefore, one way to prevent inventory shrinkage from happening is to make sure employees know and understand the consequences of stealing. Additionally, companies should offer employee incentives to deter theft.

In the case of product returns, one way to prevent inventory shrinkage is to offer customers easy returns. Using online returns, not only does the company receive a lower price for the product, but they also have a better understanding of how many returns are taking place. Additionally, if customers are no longer able to return the product via the company, they may choose to resell the item. Therefore, making this process as convenient for the customer as possible can eliminate the need for inventory shrinkage.

Retail Shrink Due to Clerical and Stock Control Errors

There’s a lot of paperwork involved in running a retail business, including invoicing customers, tracking inventory, creating manufacturing orders and the list goes on. All this paperwork is necessary in order to run a smooth business operation and ensure that mistakes do not creep into your books and affect inventory and stock control.

Despite all the checks and balances, miscommunication between sales, inventory and internal bookkeeping occurs on a regular basis. This leads to an erroneous stock count that needs to be rectified. If you’re a business owner, it is important that you meet with your bookkeeper regularly and ask them about inventory shrinkage. If you regularly meet in the middle of the day for these scheduled meetings, it will help improve communication. When a miscommunication occurs, it is very easy for the issue to get overlooked, and the solution to remain hidden. The best way to seek the answer to your questions on inventory shrinkage is to meet as often as you need to.

Inventory shrinkage can be caused by both internal errors and external factors. Internal errors like clerical or data entry errors are a major cause of inventory shrinkage. Other causes of errors are if your customers are not recording all the information as it is necessary to maintain an accurate stock count, or if you are not collecting it as it is required by tax laws.

How to Minimize & Prevent Inventory Shrinkage

Shrinkage, otherwise known as inventory shrinkage, is defined as the reduction in net inventory holder cost, when compared to the historical cost, caused by inventory theft, carelessness, inaccurate pricing, and inefficient storage procedures.

In the modern world of commerce, obsolete items tend to pile up in your storage room, closets, and stockrooms. As time passes, these items end up taking up space unnecessarily, and hence it can be immensely beneficial to keep a check on inventory shrinkage.

Shrinkage signifies loss or devaluation which is important to understand because theft, careless handling of inventory items, inaccuracy in pricing, and inefficient storage systems, are all factors that lead to devaluation of inventory items.

Once items become damaged or show signs of a gradual loss in value, thieves are the likeliest culprits to snoop into any unguarded area and swipe away expensive goods with no regards to the company’s financial well-being.

The damage caused by these loss causes your company to lose money that could have been earned if the stolen inventory items were properly stored. Therefore, it becomes extremely important to minimize and prevent inventory shrinkage.

Prevent Retail Shrink From Inventory Control and Clerical Errors

Retail shrinkage is a cost of doing business in the retail industry and accounts for the inevitable loss in product that does not make it to the final customer. Every store has its own definition of what they consider retail shrink; however, retail shrink is any loss that occurs before the product makes it to the customer.

Here are the four most common types of retail shrink:

{1}. Inventory shrink: The loss in inventory that didn’t sell
{2}. Theft shrink: The loss in product that was stolen from the store
{3}. Administrative shrink: The loss in product that found its way to the wrong customer
{4}. Clerical errors: The loss in product that was improperly recorded

Shrinkage can be due to a multitude of reasons, including lack of customer service, lax inventory management and poor shippers. Identifying and effectively preventing shrinkage will help retailers protect their bottom line.

Prevent Retail Shrink Caused by Customer Theft

Prices seem to be decreasing on almost all product categories, though consumers may not realize it. One such category is retail. Online stores are cutting out much of the overhead costs that brick-and-mortar stores have to deal with.

Both large and small retailers may need to think about inventory shrinkage as a valuable loss prevention tool. One way to do this is to use loss prevention big data analytics.

If you do not have a system set up already that gathers data efficiently and is in touch with your physical environment, it might be time to create such a system. It’s hard to identify and prevent shrinkage if you do not know the inventory’s value.

The growing virtual footprint of online retailers poses the ever-growing problem of shrinkage to the retail industry, and retailers are loathe to admit in their annual reports that the biggest loss might be from unsold inventory.

The loss prevention industry estimates that almost half of all shrinkage is due to employee theft, and that much more goes unreported than is reported.

By using loss prevention big data analytics, retailers can find out the causes of shrinkage, prevent shrinkage, and maximize profits. The figure below shows the collected data for a single 8 x 10 ft. retail store.

Prevent Retail Shrink by Deterring Employee Theft

Any business owner understands that theft costs a lot of money. It’s an unfortunate fact of life that petty theft occurs even in the most reputable and well-supervised businesses, but the goal of any business owner should be to minimize the risk of loss while providing their customers with the best possible service and products.

If you operate as a retail business, it’s important to protect the property and assets of the business. This can be done by conducting regular inventories and practices to ensure the accuracy of your inventory count.

The Shrinkage Loss Prevention Association defines inventory shrinkage as, –The difference between the recorded inventory and the actual inventory on hand.” Some reports that inventory shrinkage is also referred to as the quantity variations, distribution losses, stock losses, material losses and other names.

What Is Inventory and How Does It Affect Your Company?

When we speak of inventory, we are referring to products for which we have taken the manufacturer’s serial numbers, price, weight, etc., and have recorded this information on an inventory management system or in a paper register.

This information is important because the math used to determine the inventory value of the product allows the business owner to make the profitability analysis of the company and to know the amount of revenue we need for the same.

Bottom Line

Inventory Shrinkage

Inventory shrinkage is a direct reduction in the value of an inventory. This includes both lost sales and stolen merchandise. Shrinkage can occur when the customer pays for merchandise that is stolen from the store or when the customer insists on a refund for unsold merchandise.

Inventory shrinkage is a direct reduction in cash reported to the accounting department. Losses reported might be much higher than actual losses. The loss should be spread evenly to all in stock – this is known as "chargebacks."

NOTE: Shrinkage is NOT theft. For theft purposes, the actual loss must be valued at the market price of the goods. You cannot expect to have a positive profit margin on stolen merchandise.

If a customer has their goods stolen from the store, the store is not compensated for the loss. A major difference between theft and inventory shrinkage is that the loss from shrinkage is usually much higher. It can be the difference between a profit and a loss.