Blog Cin7 A detailed guide to preventing inventory shrinkage
31 May, 2022

A detailed guide to preventing inventory shrinkage

What is inventory shrinkage?

If you own a retail business, you’ve likely experienced inventory losses. Unplanned inventory loss, known as inventory shrinkage, results from a myriad of causes including theft, shoplifting, and damage both in-store and in-warehouse.

For example, Rio Shoes, Ltd., had 4820 pairs of shoes, but, upon a physical count, the inventory was only 3980.

According to the 2020 Retail Security Survey published by the National Retail Foundation, inventory shrinkage cost the retail industry $61.7 billion in 2020. Retailers need to take steps to prevent unwanted loss that results in decreased profitability.

“In a business where we only make a penny on every dollar that comes in, it is especially important that we control our shrinkage.”

Fred Klein, VP Loss Prevention, Big V Supermarkets

Here, we will learn why it’s important to calculate inventory shrinkage rate, how to calculate the rate, and how to prevent or reduce inventory shrinkage.

What are the leading causes of inventory shrinkage?

There are several reasons that contribute to inventory shrinkage. However, the top reasons include shoplifting, employee theft, administrative and paperwork errors, and vendor fraud or error.

According to the 2021 Retail Security Survey, participating retailers indicated that these loss risks and threats have become more of a priority for their organization over the last five years:

Why is calculating inventory shrinkage important?

It is well-known that physical inventory in the retail business consumes an enormous amount of working capital.

Inventory is money that is stashed in your warehouse. 

This only highlights the importance of identifying the sources of inventory loss and stopping or decreasing the causes.

A certain amount of inventory loss will be attributed to damaged goods. However, concerted efforts and corrective actions must be taken to eliminate unethical reasons such as theft.

“Not controlling shrinkage is taking a shortcut to bankruptcy.”

John L. Pagliaro, President of Dana Associates

How to calculate inventory shrinkage

Inventory shrinkage and rate are determined for a specified period, such as the fiscal quarter or year. Inventory shrinkage is calculated by subtracting actual inventory value by recorded inventory value. The shrinkage rate is calculated by dividing inventory losses by the amount of inventory you should have, and multiplying that number by 100 to determine the rate.

To calculate the rate, you’ll need to determine the following:

  • A physical count of actual inventory and its value.
  • The recorded inventory, or inventory you should have, and its value.
  • Deduct the value of actual inventory from the recorded value to determine inventory loss (inventory shrinkage).
  • To calculate the rate, divide inventory loss (inventory shrinkage) by the recorded inventory and multiply by 100.

Inventory shrinkage = recorded inventory value – actual inventory value

Inventory shrinkage rate = inventory shrinkage / recorded inventory value * 100

For example: Joe’s Accessories has $5200 mobile accessories. After conducting an actual inventory count, they determine the value on hand is only $4900. Joe’s Accessories realized inventory shrinkage of $300 with a rate of 5.7% over a specified period (fiscal quarter or year).

Inventory Shrinkage = $300 ($5200 [recorded inventory] – $4900 [physical inventory])

Rate = 5.7% ($300 [inventory shrinkage] / $5200 [recorded inventory] * 100)

How to prevent inventory shrinkage

A combination of safety measures can be implemented to reduce or prevent inventory shrinkage. Some of those include:

1. Implement a two-person checks and balances system

A checks and balances system is a system that can be implemented at crucial inventory management stages like signing invoices, accepting stock, and recording stock.

Having a second person verify records prevents inaccuracies and omissions. It can identify loopholes contributing to stock shrinkage so that measures can be implemented to control fraud.

2. Safeguard expensive inventory

Inventory shrinkage is measured in terms of value. Safeguard expensive items by assigning employees with special privileges to handle that inventory, or store expensive items under lock and key in a separate location.

3. Prevent vendor and purchase order fraud

Follow-up with vendors to ensure your purchase manager isn’t involved in transactions that are questionable or unethical in nature. Double-check damaged goods that are filtered from purchase orders. Employ inventory management software like Cin7 that provides trackbacks and purchase order history.

4. Eliminate loopholes and improvise process

Identifying loopholes to prevent employees from exploiting inventory can significantly reduce inventory shrinkage.

5. Increase pre-employment screening

Small items such as truffles, caviar, gemstones, and small electronic devices are high value and easy to steal. Boost pre-employment screening to include:

  • Background checks
  • Criminal history
  • Credit history
  • Education verification
  • Past employment history

6. Employee training and incentives

Proper loss prevention training will reduce shrinkage. In addition to loss prevention training, employee incentives. Create a strong company culture that fosters honesty and integrity.

7. Invest in a security system

A lot of hardware systems with software support are available on the market to safeguard inventory from being stolen. These systems include CCTV cameras, intrusion detection, door auto lock systems, and door access control.

Alternatively, you can install a custom system according to your needs and budget to reduce theft as well as unauthorized access to your warehouse.

8. Track your inventory

Using the latest technology business owners can track inventory as it moves from procurement to sale. Examples of tracking devices include radio frequency identification (RFID) tagging and bar codes.

9. Invest in an inventory management system

The role of an inventory management system is to monitor movement of products from procurement through production to sale. A good system will allow you to track inventory to a specific location whether that is a bin in a warehouse or a store shelf.

An inventory management system ensures that you have enough inventory (stock) to meet demand without overstocking.

What if inventory shrinkage goes unnoticed?

Missing inventory will adversely affect your profits.

“Shrinkage is the single greatest threat to profitability in our industry.”

Alasdair McKichan, President, Retail Council of Canada.

Here’s an example: Joe’s Accessories sells accessories at a 20% profit. When inventory valued at $1000 is missing (inventory shrinkage), his profit loss is $1200 ($1000 + 20%). Joe’s Accessories loses the actual value of the inventory ($1000) plus the profits that would have been earned by selling the lost inventory (20%).

Ultimately, shrinkage will need to be reconciled in your books. These are recorded as business losses. Significant inventory shrinkage is a monetary loss. Inventory has value – even stock that has been sitting around a while or was acquired through trade or barter.

Final thoughts

Inventory shrinkage can affect your bottom line – at the very least. It can also have deleterious effects on business and employee relations. To boost profits, business owners need to lower their inventory shrinkage rate. The most efficient way to do so is to use the latest and most efficient method of inventory management.

With the use of software systems like Cin7, inventory shrinkage is readily caught and resolved efficiently.

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