Inventory Shrinkage: What Causes It and How to Stop It

Last updated on September 10th, 2024 at 09:11 am

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:

• What Is Inventory Shrinkage?
• Inventory Shrinkage Calculation
• What Causes Inventory Shrinkage?
• How Does Inventory Shrinkage Impact Brands?
• 6 Ways to Stop and Prevent Inventory Shrinkage 

What Is Inventory Shrinkage?

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. 

Inventory shrinkage calculation 

 To calculate inventory shrinkage, follow these steps:

1. Determine the recorded inventory: This is the amount of inventory that should be on hand according to your records.
2. Conduct a physical inventory count: This is the actual count of inventory on hand.
3. Calculate the shrinkage amount: Subtract the physical inventory count from the recorded inventory.
4. Calculate the shrinkage rate: If you prefer to calculate the inventory shrinkage rate, divide the shrinkage amount by the recorded inventory and multiply by 100 to get a percentage.

The formula for inventory shrinkage is:

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The formula for inventory shrinkage rate is:

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What Causes Inventory Shrinkage?

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.

Theft

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. 

Administrative errors

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. 

Supplier fraud

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. 

Damage

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 inventory

Misplaced or poorly organized products within the store or storage area may not be found during inventory counts. 

Administrative policies

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.

Inefficient inventory management 

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.

How Does Inventory Shrinkage Impact Brands?

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.

6 Ways to Stop and Prevent Inventory Shrinkage 

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.

1. Implement or strengthen security measures

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. 

2. Invest in employee training

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. 

3. Upgrade inventory management systems

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. 

4. Strengthen vendor relationships

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. 

5. Optimize store layout and organization

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. 

6. Implement strong administrative policies

Ensure accurate record-keeping for all transactions, including sales, returns, and exchanges. It’s also important to correctly document damaged or discarded items.

Manage Inventory With NewStore

Are inventory discrepancies affecting your sales and profitability? The NewStore platform natively includes inventory management. Replace your legacy system to gain full visibility into your inventory with real-time data per location and SKU, ensuring accurate stock levels and increasing your team’s ability to sell down to the last unit.

Request a demo today.