What is Inventory Shrinkage & How Do You Prevent It?

Inventory shrinkage could be slowly eating away at your profits without you even realising. In fact, it has been said to cost the industry as a whole over $60billion.

This guide takes you through what it is, how to calculate it and how to prevent it.

What is inventory shrinkage & how to calculate it?

Inventory shrinkage is the difference between the actual inventory you have and the recorded amount. Before you start worrying about inventory shrinkage (AKA missing stock), it needs to be accurately calculated. The formula is:

Inventory shrinkage = (recorded inventory – actual inventory)/recorded inventory

To convert this to a percentage multiply the end figure by 100.

Example inventory shrinkage calculation 

The best way to understand this fully is to look at an example:

The current recorded inventory is £70,000. 
The actual inventory is £63,000.

Therefore inventory shrinkage rate is 10% *+((£70,000-£63,000)/£70,000 = .10)*100)

In other words, 10% of your inventory stock is missing due to shrinkage.

Why not use this calculate to work our your inventory shrinkage!

What are the main causes of inventory shrinkage?

Administrative/accounting errors

Administrative and accounting errors can occur when stocktaking is done badly. Items may be counted wrongly or incorrect units of measurement used. When using inventory management software, this is far less likely to happen, unless incorrect amounts are keyed in.

Shoplifting

Research has shown that shoplifting accounts for as much as 38% of all inventory shrinkage. Shoplifting will not be a problem if you run an e-commerce store only. But for those with physical stores, this can account for huge losses. 

There are ways of preventing this such as using cameras, mirrors, security guards, tagged high-value products and locked display cases.

Employee theft

Sheer ID found that employee theft accounts for around 40% of inventory shrinkage.
Employees have access to all products so the possibility of them stealing is a very real one. This can be halted by using correct warehousing entry control, enhancing security and dealing with it in the right way if people are caught in the act.

Damage

As for damage, this is down to goods not being packed, handled or stored correctly. Watch out for split boxes, water damage, product expiration dates etc.

Twelve ways to prevent inventory shrinkage 

Inventory shrinkage may be a very real problem but there are ways to prevent it. Let’s look at eight of them:

Implement Employee screening

NRF research actually shows more than 35% of inventory shrinkage is caused by thieving employees.

Proper references and background checks are a must to identify any potential issues when hiring new staff for a warehouse or shop. It’s easy to just employ someone on the spot after a successful interview without considering their past, but a little research can go a long way.

It may be worth contacting previous employers to find out how effective the candidate has proven to be in handling inventory. Any history in inventory management — and doing it well — is a real advantage. 

Train your team properly

Once you have hired someone, the next step is to train them. This seems obvious but anyone who has ever managed someone knows: it’s hard to do this when you are busy.

Employees should be aware of the whole concept of inventory shrinkage, and the danger it poses to the business. (And therefore their livelihoods.)

It’s important for them to know that a little oversight here or an error there does have an effect on the bottom line.
But it’s also up to you as an employer to give them what they need in order to minimise errors and stop carelessness.

This means having easy-to-use inventory systems that don’t require too much technical knowledge to master. Then providing adequate onboarding for new staff and regular general training on an ongoing basis.

Give every product variant a SKU

Use a SKU (stock-keeping unit) for every product. Giving each product a SKU allows workers across the business (from warehouse staff to administrators) to track inventory levels more efficiently.
It’s vital to keep the SKUs consistent across sales channels, warehouses, systems and anywhere else being used. This way, you’ll be able to more easily keep track of exactly where product variants are and minimise the risk of anything getting lost.

Surveillance 

Place security cameras with good image quality throughout anywhere else that stock is handled. You could also place high visibility ‘theft’ warning signs in places where stock is held. By keeping an eye on inventory (particularly where high-value goods are involved), theft can be minimised.

Security measures 

Beware of external theft too. Fence in warehouses and administer strict security protocol to control access. If the stock is very high value, consider having a night-time security patrol. Warehouses are huge targets for thieves, as they know there will be a large number of goods in one place. Better to spend money on security rather than losing profit due to inventory shrinkage.

Do regular inventory counts

An obvious way of keeping on top of your inventory is counting it! You can do this through the traditional manual method. However, this could involve shutting down operations. It’s also unlikely that you will be able to do this frequently if you have a significant amount of stock.

Instead, you could introduce inventory cycle counts. Inventory cycle counting is a way of having your pickers regularly carry out inventory counts of portions of your stock. It often goes hand in hand with having a barcode inventory system. It helps keep a more accurate count of your stock at any time. You can learn more about inventory counts here.

This is a process Veeqo makes easy through automation and even produces a dedicated report.

Lessen temptation 

For those with a retail store, goods of high value need to be stored in locked cabinets or have security tags attached. Would-be buyers can only examine the goods in the presence of an assistant, making it much more tough to be stolen.

Be on the lookout for fraudulent sale transactions 

Sales fraud takes many forms so do watch out for any of the following:

1. Employees entering a larger quantity of goods sold and then stealing the excess.
2. Fake customer accounts being set up. Goods are then sold to an address that the employee can collect from, with bills never being paid.
3. Fake supplier accounts used to pay for products that never arrive at your warehouse. The employee takes the money.
4. Theft via coupons and promotional offer scams. This is not so easy to do online but physical stores can find stocks depleted due to large amounts of coupon redemptions. If your staff or your inventory management software flag up suspicious behaviour, do investigate as it could be a sign that fraud is taking place.
5. Vendor kickback schemes occur when an employee creates a relationship with one of your suppliers. You pay more than you should with the employee taking their cut for arranging the scheme.

These types of issues can be dealt with once you become aware of their potential to exist. For example, don’t let any one person deal with large orders – split up the responsibilities between several people. One might look after getting the sale approved and another look after the despatch from the warehouse. This reduces the likelihood of one person being able to conduct a large amount of fraud, as the processes are made far more transparent. This removes temptation and protects the company.

Prevent fraudulent shipping 

Warehouses are busy places and this can make it more difficult to detect fraud. With goods coming in and out daily, it’s no wonder that much of employee theft takes place in the goods received/goods out departments. 
To prevent theft, you need to carry out checks on goods received notes for ‘faulty’ items. You need to physically ensure that these goods exist and that they are faulty or damaged. The employee that carries out this check must be someone not involved with shipping; otherwise, you may find a conflict of interests occurring. Keep records of all inspection reports and be on the lookout for odd trends or patterns before digging deeper.

Store inventory appropriately

Appropriate inventory storage is crucial to stop products from being damaged while sitting in the warehouse. Especially for fragile or perishable items.
This means:

• Using padding on shelves, where needed.
• Storing heavy and/or most fragile items closest to the floor.
• Maintaining the appropriate temperature, where needed.
• Giving your team necessary equipment.

And just being intentional and logical with your storing procedures.
It’s also worth adopting a FIFO (first-in-first-out) system to give each item as little time in the warehouse as possible.

Track and monitor your purchases

While it’s not the most common cause of inventory shrinkage, vendor fraud is still worth preventing. You can do this by,

• Only using reputable suppliers and/or vetting them before use.
• Staying organised with your purchase orders so you can easily track which are in-transit, late, delivered, etc.
• Systematically following up on late deliveries.
• Having a solid count and book-in procedure when orders arrive at the warehouse.

You can even use a barcode scanner to make this book-in and put away process quicker and easier. All ensuring vendor deliveries are completed accurately and in full – with errors or fraud caught early.

Put in place a real-time tracking system for inventory

This provides management with actual inventory totals in real-time. You will be able to check on the status of raw materials in stock and goods in the sales pipeline. As the owner or manager of an e-commerce fulfilment store, you need to know where your inventory is at any given time. Whilst this can be done manually, nothing keeps track more efficiently than inventory management software. 

By doing spot checks, you can see where each item of stock is and pinpoint any missing goods. You decide whether you want to check stock locations individually or in packaged lots, as they are ready to leave the warehouse.

How to factor in inventory shrinkage

Some businesses factor in inventory shrinkage by adjusting their prices to cover the losses but this can be detrimental if it makes your products less attractive than those of your competitor. This is referred to as offsetting or factoring in the cost of inventory shrinkage. You will also find that your supplier hikes their prices up if they have similar issues. These price increases are passed down the chain from wholesaler/manufacturer to retailer and ultimately become the burden of the customer.

Whilst factoring in inventory shrinkage is a common technique, the aim should always be to keep your prices low. This can only be done once you effectively reduce your inventory shrinkage. Lower prices enable your sales to remain healthy and can give you an edge when it comes to competitor products.

The problems caused by inventory shrinkage

Inventory shrinkage causes many problems and if left untreated, will eventually harm the company’s profits. Should you find your multi-channel e-commerce store at the mercy of this common problem, you can expect to experience any of the following:

Reduced revenue 

Each time that inventory goes missing, you have lost the ability to generate revenue from that item. It also negatively affects profits because your store has to absorb the cost of purchasing the goods. High shrinkage rates can result in major losses, even contributing to the downfall of the business.

Loss of trust 

Unpleasantness occurs when you suspect employees of theft, so much so that the internal culture of the business can be affected. Imagine how staff and management feel when you have to put in place bag and coat checks before employees leaving the site. The feeling of goodwill and camaraderie that was present before evaporates and can create an ‘us and them’ barrier between staff and management. Worst of all, staff that are not involved are dragged into the problem and can begin to feel guilty by association even when they have done nothing. The ultimate result of this is a downward slide in morale.

The impact upon customer service 

This is not so much of a problem with multi-channel e-commerce stores but can be a major issue for retail outlets. When staff know that shoplifting is creating shrinkage, their attitude towards customers can be less helpful and friendly. 
Once you have to put in place processes to prevent shoplifters from attacking your store, this can also affect customer service negatively. Imagine a store with signs on the wall, asking customers to leave bags and coats at the door, or have them searched on the way out; this is going to put people off coming in. The avid use of scanners, cameras and security staff can all deter customers.

Management involvement 

Once management begins to get bogged down with taking care of inventory shrinkage, their attention is diverted from essential issues. Business development, employee training, product improvement – all of these things get pushed to the side, having a detrimental impact upon the business and its success.

What is a normal inventory shrinkage level?

According to the 2020 National Retail Security Survey, inventory shrinkage accounted for 1.62% of a retailer’s bottom line. With seven out of ten saying they had a shrink rate that exceeds 1%.

Is inventory shrinkage an expense?

Businesses should treat inventory shrinkage as an expense and record it in the accounts. The way you do this will depend upon the extent of the loss. If the shrinkage is small then it can simply be shown as a debit in the cost of goods sold account. For larger sums, always discuss the issue with your accountant. 

If you’ve found this guide useful, you may also be interested in one of our many inventory management guides. Or, if you are looking to level up your inventory management in general, you may want to take a look at what Veeqo’s inventory management software can do for you.