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More Inventory Content
Get the latest e-commerce industry news, best practices, and product updates!
What is Inventory Shrinkage?
Inventory shrinkage is the excess amount of inventory recorded in a company’s accounting records that do not exist in the actual inventory. In other words, the difference between the accounting records of inventory and the inventory present in the warehouse is the shrinkage of inventory. Inventory shrinkage occurs when the retailer has less stock in his inventory than is stated in the inventory list.
Mainly, inventory shrinkage occurs due to clerical errors, goods getting damaged or stolen, miscounting of the goods, lost goods, incorrect units of measure, etc. Another common reason for the occurrence of inventory shrinkage is supplier fraud. It may happen that the supplier sent a certain number of goods less than what is stated in the list of supplied items. Hence, the supplier deliberately caused the fraud.
Therefore, the difference between the list of inventory and the actual inventory is inventory shrinkage.
Example of Inventory Shrinkage
When running a business, you are most likely to encounter situations involving unforeseen costs and unplanned expenses. However, inventory shrinkage is neither of them but can result in both of them.
The formula for calculating inventory shrinkage is:
Inventory shrinkage= recorded inventory – actual inventory
Where,Recorded Inventory = Inventory – Cost of Goods Sold (COGS)
Therefore, inventory shrinkage can be demonstrated with the help of this particular example:
Let’s just assume that you have recorded Rs 1,00,000 as the value of inventory and your cost of goods sold (COGS) is Rs 20,000.
Therefore, the book value of your inventory will be Rs 80,000 (1,00,000- 20,000= 80,000).
Now, when going through the inventory, you may see that the value of your actual inventory is Rs 70,000, whereas it should have been Rs 80,000.
Hence, this difference of Rs 10,000 (80,000- 70,000= 10,000) is the value of inventory that you lost due to inventory shrinkage.
How to Calculate Inventory Shrinkage Rate
It is important to calculate the inventory shrinkage rate to assess how much of your business’ inventory has been lost due to shrinkage. The lower the inventory shrinkage rate, the less inventory you lose due to shrinkage. Hence, the lower the rate of inventory shrinkage, the better for your company. However, when trying to understand the inventory shrinkage rate, you may proceed further this way:
Let’s just assume that you have recorded Rs 1,00,000 as the value of inventory and your cost of goods sold (COGS) is Rs 20,000.
Therefore, the book value of your inventory will be Rs 80,000 (1,00,000- 20,000= 80,000).
Now, when going through the inventory, you may see that the value of your actual inventory is Rs 70,000, whereas it should have been Rs 80,000.
This difference of Rs 10,000 (80,000- 70,000= 10,000) is your inventory shrinkage.
The formula for calculating the inventory shrinkage rate is:
Inventory Shrinkage Rate = (Recorded Inventory – Actual Inventory) / Recorded Inventory
Then, multiply your inventory shrinkage rate by 100, converting it into a percentage.
Inventory shrinkage rate= (80,000- 70,000)/ 80,000
Inventory shrinkage rate= 10,000/ 80,000
Inventory shrinkage rate= 0.125x 100
Inventory shrinkage rate= 12.5%
Therefore, the inventory shrinkage rate of your company is 12.5%, indicating that you have lost 12.5% of your inventory due to inventory shrinkage.
The Main Causes of Inventory Shrinkage
Numerous causes are responsible for the shrinkage of Inventory in any company. The National Retail Security Survey outlines some of them the leading reasons for inventory shrinkage, as follows:
Consumer Theft
Consumer theft is popularly known as shoplifting. It occurs when the customer takes home more products than they have paid for to the cashier. The act of stealing that the customer performs known as shoplifting or consumer theft. As per the national retail security survey, it has been noted that shoplifting is responsible for 38% of the company’s inventory shrinkage. It is even more than employee theft and is the leading cause of inventory shrinkage as per the reports of 2016 and till now stands still.
Surprisingly, almost all stores and shops nowadays have CCTV surveillance cameras, digital tags, unique codes for each product, and many other security means. Still, few customers manage to steal, contributing to inventory shrinkage.
Employee Theft
Employers hire employees to work for their company and stand at the forefront to protect and look after inventory. But there can be a few dishonest employees in a company who may steal the stock or items from a large inventory. It may be because they think they are being undervalued, underappreciated, or underpaid for their service, or it can also be just their kleptomaniac behavior.
However, from over a thousand items in the inventory, even if employees steal a few products, it is unlikely that the employer or accountant will notice such behavior. They may think the item just went missing when arriving or leaving the warehouse as per production or delivery needs.
Management Errors
Some of the management and administrative errors are the significant causes of inventory shrinkage. Technological advancement has made a noticeable change in arranging and managing inventory. Previously, the counting and managing inventory were done manually whereas, nowadays, it has shifted towards automated systems of the digital method of record keeping.
Although automated systems are encouraged, there should still be manual counting of inventory so that the glitches of digital reporting methods can be avoided. Such mistakes can be marking the price, and accidental reorders missing or additional zeros, decimal points that are left out, etc.
Accounting And Tax Miscalculations
An error in accounting and tax calculation may occur when you are manually calculating and recording the stock in the inventory. Nowadays, it is highly likely that all the companies are using automated record-keeping software, and the accounting and tax calculations are also done using computers or any other technological device. But when you resort to manual accounting and tax calculations, the chances of errors increase.
Manual paperwork can also lead to counting and spreadsheet errors, which can have a negative effect when forecasting reports are prepared based on sales trends. Therefore, these are all the significant causes of inventory shrinkage. There are also other minor causes as well such as supplier fraud, clerical errors, negligence of employees, etc.
Loss Of Product
It is a likely possibility that a product may get lost in a large inventory. Suppose a product goes missing or is lost. In that case, it contributes to inventory shrinkage as that amount of merchandise cannot be sold because the product is missing altogether. It is possible the product may go missing or get lost due to the negligence of the staff working in the inventory. It may also get lost in transit or when the product is out for packaging or delivery to the customers.
However, the act of product loss is not due to any act of deceiving motive by any company employee. It is a mistake in good faith, and the employer should keep a tab on the employees working for the company’s good.
Money Thrown Away
It is a broad term that aptly describes the problem of money and payments in the business, resulting in inventory shrinkage. The main reason for this category of inventory shrinkage is fraudulent payments. Nowadays, it is effortless to pay whoever we want just by using the different online payment modes. In this way, it can also happen that the employees may make fraudulent online payments to people not meant to receive the payments.
Another essential aspect of money thrown away can be the overpayments to vendors and suppliers done by mistake. There may have been a recounting of the same stock, and money has been paid to the vendors in a double because of the counting mistake. This results in inventory shrinkage.
Damage
It is a genuine cause where technically, no single person is at fault. This is not a cause where anybody is trying to deceive the employer. It can very well be a possibility that the products or the inventory stock get damaged for various reasons. As the damaged products cannot be sold in the market, they are considered inventory shrinkage and waste products. Although the damaged products can be repaired and reused to sell if possible, if not, then they are a part of the shrink inventory.
Inventory Shrinkage Journal Entry
It is imperative to revise your accounting books when facing shrinkage in your inventory, which has been persistent. You need to increase your shrinkage expense account and decrease your inventory account to record the inventory shrinkage as losses.
In simple accounting language, deduct from your shrinkage expense account and credit your inventory account. By doing so, you can adjust the losses that inventory shrinkage has created.
Create a journal entry in your accounting books to adjust your inventory shrinkage. The journal entry should look like this:
Shrinkage expense account… dr. 2,000
To Inventory account…… 2,000
Let’s just assume that the value of inventory shrinkage is Rs 2,000. When you have recorded a higher inventory value, you have to decrease that and deduct the Rs 2,000 from your inventory account and the Rs 2,000 to your shrinkage expense account to reflect the inventory shrinkage in your accounting book.
Therefore, a journal entry in the books of accounts is essential to reflect the shrinkage in the inventory.
How to Reduce Inventory Shrinkage
Reducing inventory shrinkage will reduce the company’s losses which can also be considered extra expenses. It is crucial to minimize the inventory shrinkage, and here are some of how you can control the inventory shrinkage in your company. The measures to reduce inventory shrinkage are as follows:
Recounting Of Inventory
It is better to count your inventory to keep them in check and record the results. You can do it cyclically by allotting the whole process in different shifts and to varying employees, as it is time-consuming. It is better to manually count the inventory than Reliance on any software.
Install Tracking Device
installation of tracking devices has helped many retailers overcome the problem of inventory shrinkage to a large extent. Just like clothing retailers have achieved great success with the use of inkblot tags.
Implementation Of A Double-Check System
Implementing a double-check system should be a must in every critical inventory. For instance, for better management, more than one person should be assigned to sign invoices and count necessary inventory in and out. The assignment of one job to more than one person prevents the chances of inaccuracy and omission of important details.
Background Checks On Employees
If there is a possibility of some employees in your company committing employee theft, then it is essential to identify such employees. It is vital to run a background check on the employees before hiring them, just to be safe. A company should contact fast employers of the candidates for hiring them so that they do not hire fraudulent employees.
Increase The Security Measures
If there is a continuous and persistent inventory shrinkage in your company, then it is necessary to increase the security measures. A possibility is that there is an occurrence of employee theft or consumer theft in your company. To recognize and eliminate that, it is necessary to increase the security measures in your store so that you can continuously watch all the happenings in and around the store.
Remove Damaged Products From The Stock Count
Sometimes there is a possibility that the damaged products are also taken in the count of inventory but are not an actual inventory. As damaged products can’t be sold to the consumers, they are considered waste and should be excluded from actual inventory. When you identify a damaged product, immediately exclude it from the stock and adjust the inventory count accordingly.
Conduct Regular Audits
Audits are a great measure of checking on the inventory from time to time. Comparing the sales reports with the inventory reports constantly diminishes the possibility of inventory shrinkage. Conducting regular audits will do away with the discrepancies of shrinkage in inventory. Audits also check the accounting to see if it’s accurate.
Use Software And Automated Devices
With never-ending technology advancement, it is advisable to automate the processes as far as possible. But that does not mean it is advisable to do away with all the manual processes. You can install inventory tracking software to track and count the inventory. It will make your data more accurate. However, it is not feasible to use software and automate the processes everywhere. So, install automatic devices and software wherever possible, and you may leave the areas that don’t come under such possibility.
Create A Strong Inventory Management System
It can be said to be a primary step towards the betterment of the management in the inventory area. A solid inventory management system will constantly act as a supervisor of the inventory and take care of them. A robust inventory management system will also be more efficient while tracking and managing the inventory. It will also help keep a tab on the clerical errors resulting in inventory shrinkage. Doing away with the administrative and management errors will greatly reduce inventory shrinkage to a great extent.
The above are tips and measures you can apply to reduce your company’s inventory shrinkage.
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FAQs
The difference between the recorded inventory and the actual inventory is known as inventory shrinkage. Where the recorded inventory is more than the actual inventory, the excess inventory that is recorded in the company’s accounting books is termed inventory shrinkage.
Inventory shrinkage is not good and positive for your company as it increases its losses. These increased losses are termed shrinkage expenses debited in your company’s accounting books.
The three main types of inventory shrink are:
- Shoplifting, also known as consumer theft
- Employee theft
- Clerical errors (management and administrative)
You can better understand the concept of inventory shrinkage with the help of the following example:
Let’s just assume that you have recorded Rs 10,000 as the value of inventory and your cost of goods sold (COGS) is Rs 2,000.
Therefore, the book value of your inventory will be Rs 80,000 (10,000- 2,000= 8,000).
Now, when going through the inventory, you may see that the value of your actual inventory is Rs 7,000 whereas it should have been Rs 8,000.
Therefore, this difference of Rs 1,000 (8,000- 7,000= 1,000) is the value of inventory that you lost due to inventory shrinkage.
It is crucial to control inventory shrinkage, which can be done by considering the following measures:
- Recounting of inventory
- Installation of
- Inventory tracking devices
- Strict security measures
- Seek professional help in storing and recording inventory
- Conduct regular surprise audits
