Inventory Shrinkage: What Causes It and How to Stop It
Posted by Julia Morrissey on Jul 22, 2024
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Inventory shrinkage, which is the loss of inventory that can’t be accounted for through sales or other legitimate means, is a critical issue for retailers.
According to the National Retail Federation, the average shrink rate for retail businesses in 2022 was 1.6%, resulting in $112.1 billion in losses, up from $93.9 billion in 2021. This shrinkage is primarily driven by theft, which accounts for nearly two-thirds (65%) of retailers’ shrinkage, and in some sectors, theft can represent more than 70% of overall shrink.
Addressing inventory shrinkage is essential for maintaining accurate records, reducing losses, and improving overall business profitability. This article covers how to calculate inventory shrinkage, what causes it, and how to prevent it.
Table of contents:
Inventory shrinkage refers to the loss of products in a retail business that can’t be accounted for through sales or other legitimate transactions. It represents the difference between the recorded inventory on a company’s balance sheet and the actual inventory on hand.
For example, imagine at the end of the month, a shoe store’s records show they should have 200 pairs of sneakers in stock. However, during a physical count, the manager finds only 190 pairs. This indicates an inventory shrinkage of 10 pairs of sneakers. The loss could be due to factors like shoplifting, employee theft, recording errors, or damaged shoes being discarded without proper documentation.
To calculate inventory shrinkage, follow these steps:
The formula for inventory shrinkage is:
The formula for inventory shrinkage rate is:
Several factors can lead to inventory shrinkage. Understanding the common causes of inventory management issues can enable brands to implement strategies that mitigate these problems and enhance overall inventory accuracy.
External theft, or shoplifting, occurs when customers steal products without paying for them. It’s the most common cause of inventory shrinkage in retail stores. Internal theft can also cause inventory shrinkage. This happens when employees steal products for personal use or to resell them.
Errors made during the recording of inventory data, such as incorrect entries when products are received, sold, or returned, will cause shrinkage. Mismanagement of inventory records, such as double-counting or omitting entries is also problematic.
Suppliers may deliver fewer items than what was ordered and invoiced, leading to inventory discrepancies. It’s critical to always choose to work with reputable vendors.
Products can be damaged during handling, transportation, or while on display. For example, a customer might accidentally rip a jacket while trying it on. Merchandise that is discarded due to damage needs to be properly documented in order to avoid shrinkage.
Misplaced or poorly organized products within the store or storage area may not be found during inventory counts.
Mishandling returns and exchanges and not properly recording these transactions can create inventory discrepancies. Inconsistent policies and procedures can worsen these issues, leading to further inaccuracies.
Not having a robust inventory management system can result in untracked losses, making accurate record-keeping difficult. Implementing effective inventory management practices is crucial to minimizing inventory shrinkage.
Inventory shrinkage can have significant adverse effects on a retail business.
Financially, shrinkage directly reduces profit margins, as lost inventory represents products that cannot be sold to generate revenue. This reduction in profitability can impact the business’s ability to reinvest in growth initiatives, such as expanding product lines or opening new locations.
Operationally, shrinkage disrupts inventory management processes, leading to inaccuracies in stock levels. This can result in stockouts or overstock situations, both of which can harm customer satisfaction and sales.
Additionally, internal theft, a major contributor to shrinkage, can create a toxic work environment and lower employee morale.
Overall, the impacts of inventory shrinkage are far-reaching, affecting financial health, operational efficiency, and the overall customer experience, making it a critical issue for retailers to address.
Preventing inventory shrinkage is crucial for maintaining accurate inventory records, reducing losses, and improving profitability. Here are several ways to help stop and prevent inventory shrinkage.
Putting security tags on products is an easy way to help prevent shoplifting. Additionally, installing surveillance cameras or employing store personnel can help brands monitor store areas and deter both customer and employee theft.
Educating employees on the importance of preventing theft and the impact of shrinkage on the business is essential. Further, training staff in proper handling and storage procedures can reduce damage and minimize inventory misplacement.
Implementing robust inventory management software allows for efficient monitoring of stock levels, sales tracking, and order management. Also, using barcode scanners and RFID technology can help track inventory accurately in real-time.
Be sure to thoroughly inspect all deliveries for accuracy and quality before accepting them into inventory. It’s important to establish clear contracts with suppliers that outline expectations and penalties for discrepancies. Working with reliable suppliers minimizes the risk of fraud and ensures accurate deliveries.
Organize the store in a way that minimizes blind spots to make it easier to monitor customer activity. It’s also important to keep storage areas organized to reduce the risk of misplaced inventory.
Ensure accurate record-keeping for all transactions, including sales, returns, and exchanges. It’s also important to correctly document damaged or discarded items.
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