Some businesses do a daily or weekly count of inventory to catch fraudulent activities more quickly. You might involve another employee so you can compare your numbers. First, calculate your cost of goods sold and subtract the amount from your inventory. Subtracting your cost of goods sold from your inventory shows your inventory’s book value, or the recorded amount.
Organized retail crime, where two or more people conspired to steal merchandise to resell, also falls under the shoplifting label. Price tag swapping also falls into this category, where a shoplifter pays less than what an item is worth because a different item’s SKU is recorded in the sale. Examine the financial health of your business by highlighting exactly how much revenue is being generated versus what’s being spent. The Ascent is a Motley Fool service that rates and reviews essential products for your everyday money matters. For example, certain doors could require a keycard that only some employees have so others — such as those doing general warehouse maintenance — would not have access. Get Accounting, CRM & Payroll in one integrated package with Deskera All-in-One.
- Expressing inventory shrinkage as a percentage offers insights into patterns and trends over time, prompting consideration of procedural changes.
- At the manufacturing stage, shrinkage can impede or cease production if, for instance, the manufacturer has fewer raw materials than indicated in its inventory records.
- For example, certain doors could require a keycard that only some employees have so others — such as those doing general warehouse maintenance — would not have access.
- Vendor theft is not a very large contributor to shrinkage, and many retailers will not fall prey to it.
Returns and exchanges contribute to damage-based shrinkage substantially, especially as one of the causes of retail shrinkage in traditional, non-hospitality retail environments. Either someone external does it and it’s called shoplifting or external theft, or someone internal does it and it’s called employee theft or internal theft. Inventory shrinkage occurs when the number of products in stock are fewer than those recorded on the inventory list.
Thankfully automation has gotten us pretty far in dealing with both of these problems and we’ll touch on that in a bit. Accurately calculating inventory KPI like average inventory, inventory days, and inventory carrying cost can all be automated. If the wine-bar in our example input 10 bottles of wine per case instead of 12, they would have recorded 60 bottles in their inventory instead of 72.
The good news is by monitoring this percentage over time, you can pinpoint the causes of inventory shrinkage. For example, if your shrink rate spikes sharply over a short period, you can likely attribute this to a clerical error. Training programs should be ongoing, with regular refreshers, and should also include security awareness to prevent internal theft. Engaging employees in the importance of inventory accuracy and making them aware of how their actions impact the bottom line can be motivating factors in minimizing shrinkage. Inventory shrinkage can be caused by theft, shipping damage, miscounting, and vendor fraud, as well as other factors.
But it’s harder for the wholesaler to count the 598 cases of wine they got from the vineyard. If it’s unrealistic to count, it’s unrealistic to verify that you got the right amount. Sometimes, inventory may disappear off the shelves and cannot be matched to any of the other causes of inventory shrinkage. Unknown causes represent about six percent of the total inventory shrinkage. According to a study from the National Retail Foundation, retail businesses lost $62 billion from “shrink” in 2019, amounting to an average of 1.6% of sales. When EY teams work with clients on the complex problem of shrink, we first leverage structured and unstructured data that already exists across the organization and look at it in new ways.
Consequences of inventory shrinkage
Inventory shrinkage is calculated by first subtracting actual inventory from recorded inventory and then dividing it by recorded inventory. You can convert that into a percentage by multiplying the result by 100. The next most common reason for inventory shrinkage is administrative, at 15.4%. This includes simple errors on the part of your staff such as miscounting, paperwork mistakes, or not factoring in things like inventory turnover ratio. Security checks should be a non-negotiable concept when it comes to inventory. The warehouse or the retail outlet should be covered with a web of CCTV cameras.
- To find the inventory shrinkage rate, you need to know the cost of goods sold, how much inventory you have, and how much was lost to shrinkage.
- PALMS™ Smart WMS safeguards a business’s profitability by offering real-time visibility into inventory across the enterprise and various points in the supply chain.
- For bigger ticket items, you could attach item tracking tags that are deactivated by staff when customers check out.
When a business discovers a shrinkage in its inventory, any discrepancies should be accounted for to reconcile the records with the physical inventory count. The matching principle requires that inventory shrinkage should be recorded as an expense in the financial period in which it occurred to match it against the revenues for that year. A shrinkage expense account will be recorded under word invoice template the Cost of Goods Sold (COGS) account. Shrinkage is caused from the loss of inventory due to shoplifting, administrative error, employee theft, vendor fraud, and broken items, among other reasons. This is especially negative in retail environments, where businesses operate on low margins and high volumes, meaning that retailers have to sell a large amount of product to make a profit.
Impact of inventory shrinkage on business operations and profitability
Let’s say you have $200,000 worth of inventory according to your records. You do an inventory count and find you actually have $197,000 on hand. When most retailers think of shrink, they think of theft, or shoplifting. Explore a mentorship program if you have both experienced inventory workers and newer unskilled staff members. The latter can learn from their more experienced colleagues how to properly track and inventory items to reduce mistakes. Periodic inventory checks allow a business to estimate the losses and expenses caused by the inventory.
Inventory Shrinkage – Causes, Consequences, and Tips
With a fully connected inventory management and point of sale system, you can worry less about mismatched numbers. However, there are things you can do to get your shrinkage rate as low as possible. It doesn’t take much shrinkage to make a noticeable impact on your business. Even with shrinkage lowering to 1.44% in recent years, that number translates to over $94 billion lost.
Inventory Shrinkage Calculator
Well-trained staff can drastically reduce human errors that contribute to inventory shrinkage. Inventory shrinkage occurs when the actual quantities in your inventory are smaller than what is recorded in your books or inventory management system. This usually happens due to a combination of factors, including administrative errors, damage, spoilage, theft, and supplier fraud. Accounting for inventory shrinkage is critical for an ecommerce business. The most important impact of shrinkage is that lost products can’t be sold which directly results in lost revenue. If a brand’s inventory reports don’t match sales records, someone needs to spend time reconciling accounting records.
Set up 24/7 security systems
You can spot this type of loss by examining sales figures and discount reports—this is where using a robust POS system comes in handy. External theft, like shoplifting, is one of the largest causes of shrinkage reported by retailers, accounting for 37% of all shrinkage. Inventory shrinkage can take place when items, such as expired produce, are naturally no longer sellable.
For businesses dealing with physical products, the recorded inventory often exceeds the actual on-hand inventory due to various reasons, collectively known as shrinkage. This discrepancy, whether caused by theft, fraud, manufacturing or shipping errors, spoilage, or other unfavorable factors, can lead to financial losses. Shrinkage not only impacts a company’s profits but may also prompt the need for price hikes to compensate, potentially affecting customer retention. In essence, shrinkage is the difference between recorded and physically available inventory, representing a loss that spans industries and supply chain processes. Whether it’s shoplifted goods, recording mistakes, or insufficient supplier deliveries, shrinkage remains a significant concern affecting businesses’ bottom lines.
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