Regardless of what type of products you sell, inventory shrinkage is probably a worry for you. This is due to the fact that your company’s productivity and profitability can significantly suffer if inventory is damaged, lost, or stolen.
Inventory shrinkage can lead to warehouse shortages, increased inventory costs, longer delivery times, poorer customer experience, decreased customer satisfaction, decreased customer loyalty, increased operational costs, problems with cash flow, and ultimately loss of profits.
As money is at stake, it is of course in your company’s best interest to identify and prevent shrinkage.
In this post, we provide an answer to the question, “What is inventory shrinkage?”, go through the main factors that cause inventory shrinkage, show you how to calculate it, and provide 6 tips for reducing it.
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What is Shrinkage in Inventory?
Inventory shrinkage occurs when the real, physical inventory level is lower than what is listed on a company’s inventory list. To put it another way, the business inventory listed on your company’s ledger is either missing or is very damaged and can’t be sold.
Inventory shrinkage could be slowly eating away at your profits by negatively affecting your cycle stock, i.e. the amount of inventory available to meet the increase in demand during a given time period.
When businesses discover that the retail inventory records kept by accounting and the physical counting do not match, they often notice inventory decline at year-end inventory counts. Using inventory software can help you maintain track of your inventory all year long and prevent such unpleasant surprises, although annual physical inventory audits are always necessary.
Reasons Behind Inventory Shrinkage
Inventory shrinkage can be attributed to a number of factors. However, employee theft, administrative mistakes, vendor fraud, and shoplifting are the usually main causes:
- According to the 2021 National Retail Security Survey, shoplifting incidents are at an all-time high, and each one costs retail organizations about $461 in lost revenue. When it comes to employee theft, although less common, it nevertheless costs an average of more than $1,550 per dishonest employee. Internal theft, sadly, can be difficult to detect and stop. Employees can easily steal merchandise under the radar because they have access to more remote parts of the store and are familiar with the sales and inventory management procedures.
- Human error, including mistakes by cashiers and salespeople, errors when receiving/sending stock deliveries, errors during inventory audits and data entry, etc. are also common reasons for shrinkage in inventory. With 56% of shops using it, POS analytics is still the most widely used loss prevention strategy.
- Errors and fraud by vendors may be one of the least common shrinkage sources, accounting for only 4.8% of inventory shrinkage cases, but they can still happen.
- Damaged items are unavoidable in the retail industry, regardless of whether they are damaged during shipping or by customers while they are shopping. When you find damage, be sure to swiftly change your stock count and get rid of the affected item. If you don’t, your counts will be incorrect and the missing unit will appear to be a shrinkage problem.
How to Calculate Inventory Shrinkage
In order to find out how much shrinkage your company experiences, you’ll need to calculate your inventory shrinkage rate. This rate, which is expressed as a percentage, shows how much retail inventory your company lost as a result of damage, theft, mistakes, etc. Low shrinkage rates mean less inventory lost.
In order to calculate the shrinkage rate, you need to know the COGS (cost of goods sold), the amount of inventory you have, and how much of that inventory was lost as a result of shrinkage.
Start by determining the cost of products sold, then deduct that amount from your inventory. The amount that is documented can be found by deducting your COGS from it.
Documented inventory = Inventory – COGS
After determining how much inventory you ought to have, find out how much inventory you actually have. This will show you your inventory loss. Divide your inventory loss by the amount of documented inventory to calculate the inventory shrinkage rate. To get the shrinkage rate of your company’s inventory, use the formula below:
Inventory shrinkage rate = (Documented inventory – Actual inventory) / Documented inventory
To convert your inventory loss rate into a percentage, multiply it by 100.
6 Efficient Ways to Prevent Inventory Shrinkage
Retailers can reduce the quantity of inventory lost to shrinkage each year by implementing a variety of measures. We examine six of the most effective ones below.
1. Invest in an inventory management solution
Keeping accurate stock records can be difficult if you’re currently using an inventory spreadsheet or pen and paper. Additionally, it is nearly hard to calculate and monitor the inventory shrinkage rate when a company is unable to swiftly assess the inventory that is on hand.
Thankfully, modern inventory systems like ApparelMagic are easy to set up and may make it simple to compare inventory records to the actual outcomes of your inventory audits. You’ll always be aware of how much stock you have on hand, where it is located, and how it’s being kept thanks to ApparelMagic. Using these figures, you may easily determine the shrinkage rate of your inventory, let your accounting staff write off stolen, damaged, or lost goods, or look into the history of any inventory that is experiencing shrinkage.
2. Consider using RFID technology
While QR codes and barcodes are sufficient to keep track of your inventory, RFID (radio-frequency identification) technology can help lower the danger of shoplifting by allowing businesses to monitor inventory as it moves throughout the store and can even set off an alarm when a customer leaves.
RFID technology can be costly which is why it is recommended for high-traffic retail companies that must maintain their profit margins.
3. Perform regular physical inventory counts
One way to reduce the risk of inventory shrinkage is to conduct a surprise physical count of inventory from time to time (say every couple of weeks). A surprise physical count (in addition to your regular cycle count) ought to take place entirely at random in order to prevent any pre-planning or manipulation. They will allow you to get a clear picture of what’s really happening in your warehouses or distribution centers without having to count every item on hand.
Once you have performed a count of a small inventory batch, you can quickly determine the shrinkage rate of your stock. If it exceeds your permitted limit, you’ll know to add up everything else and identify the problem’s underlying cause.
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4. Count your orders as soon as they are delivered
Counting your orders as soon as they arrive is the best way to prevent supplier fraud. By doing this, you can make sure you’re getting exactly what you paid for.
Inform your vendor as soon as possible if you notice an issue with a delivery. In addition, double-check faulty goods that are filtered from purchase orders and follow up with the supplier to make sure your buy manager isn’t involved in any dubious transactions.
5. Consider employee screening
When hiring new employees for your store or warehouse, proper references and background checks are essential in order to identify any potential problems. It’s simple to hire someone right away after a good interview without thinking about their background, but a little investigation can go a long way.
It might be worthwhile to get in touch with the candidate’s past employers to learn how successful they have been at managing inventory. Any previous inventory management practice and experience, especially when done successfully, is an important advantage. Having dependable workers in charge of your business inventory offers priceless peace of mind and lowers the risk of damages, theft, and errors.
6. Invest in a security system
There are many hardware systems with software support on the market that can help you prevent inventory theft. CCTV cameras, intruder detection, door auto lock systems, and door access control are some of these systems.
To prevent theft and unauthorized entry to your warehouse, you can also construct a custom system in accordance with your needs and budget.
The Bottom Line
Inventory shrinkage occurs in the retail industry either because of theft or administrative errors.
It is a serious problem that requires a comprehensive analysis of your business procedures and identifying loopholes. Once these loopholes are identified, you will need to find a clear way to reduce inventory shrinkage.
In this article, we provided an answer to the question, “What is shrinkage in inventory?”. We also looked at how to calculate inventory shrinkage, the problems that frequently result in shrinkage, and strategies for preventing shrinkage in the future. Be sure to use this knowledge to prevent future inventory shrinkage within your company. An effective loss prevention plan will help you eliminate, or at the very least significantly reduce, inventory shrinkage rates.