Shrinkage: Meaning & Definition

KEY TAKEAWAYS

• Inventory shrinkage is the reduction in inventory over a period of time that is not due to normal usage by customers.
• Inventory shrinkage can occur for a variety of reasons, including theft, breakage, and damage.
• Inventory shrinkage is a serious issue for many businesses, as it reduces their net income and can be difficult to recover from.
• There are several ways to prevent shrinkage and reduce its impact if it does occur at your business.

What Is Shrinkage?

The term “shrinkage” usually refers to inventory loss in a retail company. Inventory loss is a common problem in many businesses, where it is referred to as shrinkage.

Inventory shrinkage is the reduction in inventory over a period of time that is not due to normal usage by customers.

Shrinkage is the amount of inventory that is lost due to factors in shrinkage outside of the normal “shrinking” that occurs due to customers buying products.

This may include things like theft, breakage, and damage. The impact of shrinkage can greatly lower your efficiency rating. Thus it is vital that you reduce shrinkage over time as much as possible.

This guide details the steps you can take to reduce your shrinkage percentage in your company. So if you notice lower inventory through shrinkage, keep reading to find out how to put a stop to it.

Why Is Shrinkage Important?

Although inventory shrinkage is a common problem for many businesses, it is important to keep track of it because it reduces your net income. 

Inventory is usually an asset on a company’s balance sheet, so when it is lost, that reduces your net worth by an equivalent amount. 

In addition, inventory shrinkage can be a source of stress for smaller companies that have limited cash reserves. Inventory shrinkage can happen for a variety of reasons, including theft, breakage, and damage. 

All of these can be difficult to recover from, especially if they happen at a large scale. If inventory shrinkage happens at a large scale, it can be difficult to recover from. 

For example, if someone attempts to steal $50,000 worth of inventory from your warehouse one night, that amount is going to impact your business significantly.

How to Calculate Shrinkage

You calculate shrinkage by adding up the amount of inventory lost in a given period of time. This includes items that are stolen, broken, or damaged. 

You can also calculate shrinkage by taking the total inventory on hand at the beginning of the period and subtracting the amount on hand at the end of the period. 

When calculating shrinkage, you need to decide how long of a period to look at. You will generally look at either a week or a month.

The amount of time you look at will depend on your business and the types of products you have on hand.

You can also divide your total loss for the year by your average inventory value. This will give you your shrinkage rate as a percentage.

For example, if your total loss for the year was $100,000 and your average inventory value was $1,000,000, your shrinkage rate would be 10%.

How Can You Prevent Shrinkage?

You can prevent shrinkage by having proper systems in place to track inventory and monitor its movement through your warehouse. This will help you account for all inventory and help you detect when shrinkage occurs. 

Having a robust computer software inventory management system is a must when it comes to preventing shrinkage. Samples of inventory shrinkage include:

Theft

Prevent theft by hiring security guards and installing security cameras at your warehouse and retail store, and keeping an eye on employees and co-workers.

Breakage

You can reduce the amount of breakage by investing in strong packaging and shipping containers.

Damage

Damaged products can’t be sold, so you want to prevent damage as much as you can. Invest in quality products and inspect them closely before shipping them to customers.

There are many more ways you can reduce shrinkage in your business. Some of the most effective include: 

Increase Security

One of the best ways to reduce shrinkage is to increase security. This can be done in a number of ways, including installing security cameras, hiring security guards, and increasing lighting in areas where inventory is stored.

Improve Inventory Control

Another way to reduce shrinkage is to improve inventory control. This can be done by tracking inventory more carefully, conducting regular inventory audits, and instituting policies and procedures to ensure that inventory is properly accounted for.

Reduce Error and Fraud

Policies and procedures can also help to reduce error and fraud, which are two of the most common causes of shrinkage. Training employees in these policies and procedures can help to reduce shrinkage by ensuring that everyone is on the same page and knows how to properly handle inventory.

Build a Culture of Honesty and Accountability

Building a culture of honesty and accountability can also help to reduce shrinkage. This can be done by communicating the importance of reducing shrinkage to employees, instituting a rewards program for employees who report shrinkage, and holding employees accountable for their actions.

Shrinkage is a significant problem for businesses of all sizes. By taking steps to reduce shrinkage, you can protect your profits and your business.

Summary

Inventory shrinkage is a serious issue for many businesses. It is important to keep track of shrinkage because it indicates a potential problem in your business systems. 

Shrinkage can happen for a variety of reasons, including theft, breakage, and damage. It’s important to have systems in place to reduce the risk of each of these. In order to prevent shrinkage, you should have a robust computer software inventory management system in place. 

You can also take steps to reduce the risk of certain types of shrinkage. For example, you can invest in strong packaging to reduce the risk of breakage or invest in quality products and inspect them closely before shipping them to customers to reduce the risk of damage.