How Can Inventory Shrinkage Impact Your Business? 6 Causes and Ways to Prevent it From Occurring

Inventory plays a major role in the ability of eCommerce retailers to fulfill orders. Without enough inventory in stock, many problems can occur that ultimately lead to a disruption in the order fulfillment process which in turn leads to unhappy and dissatisfied customers. A common occurrence that leads to this is inventory shrinkage. Read further to understand what inventory shrinkage is, how to calculate it, causes, impacts, and preventative measures.

What is Inventory Shrinkage?

Inventory shrinkage is a common issue that plagues businesses and results in losses in different departments for companies. Inventory shrinkage can lead to a profit drop in your business unless it is addressed properly.

Inventory shrinkage refers to inventory that is reported in accounting records but does not exist in the physical inventory. It is essentially the unplanned loss of inventory due to a variety of factors, some of which are listed below:

  • Inventory theft, damage, miscounting, improper units of measure, evaporation, and other difficulties can lead to high inventory shrinkage levels.
  • Supplier fraud can also create inventory shrinkage in retail when a seller pays a supplier for a particular number of products to be supplied but the supplier does not dispatch all of the goods. As a result, the recipient records the entire cost of the products on the invoice but has fewer units in stock; inventory shrinkage is the disparity between the records and the actual stock that the seller has.
  • Shrinkage also causes profit loss. This is especially problematic in retail, as firms typically run with minute margins, have significant turnover, and are required to sell a large number of goods to remain profitable. 
  • Losses arising out of shrinkage will result in merchants being unable to repay the cost of that proportion of inventory. This is because there is no inventory to be sold or returned due to inventory shrinkage.
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How to Calculate Inventory Shrinkage?

Inventory shrinkage is determined by subtracting the total inventory received after the cycle count from the total financial worth of all inventory for the fiscal year or quarter. Inventory shrinkage is most commonly computed using the inventory shrinkage rate formula.

The following are some of the most important factors to consider while calculating the inventory shrinkage rate:

  • Determine how much inventory you have on hand.
  • Physically count the number of items in your inventory.
  • Subtract the total from the sum in your accounting journal.
  • Divide the amount by the value of inventory to arrive at a percentage.

The inventory shrinkage formula is as follows:

Inventory Shrinkage Rate = (Inventory Shrinkage / Recorded Inventory Count) * 100

To understand it better, consider the following example:

Suppose your business has 7000 pieces of a given commodity. During a physical check, you realize that there are only 6200 units. Thus:

Inventory Shrinkage = 800 [7000 (Actual Inventory) – 6200 (Physical Count)]

Inventory Shrinkage Rate = 11.4% (800(inventory shrinkage) /7000(actual inventory)) *100

Thus, your inventory shrinkage is 11.4% which implies that you have lost 11.4% of your inventory due to shrinkage.

6 Prominent Causes of Inventory Shrinkage in Retail Fulfilment

Inventory management is a crucial aspect of running a business. It can have a significant influence on the financial health of a company. Inventory is the means by which a business generates money, which appears as an asset on its financial statements. Inventory shrinkage reduces a company’s potential revenue and profit. Shrinkage can also lead to price increases, reduced employee bonuses, and a drop in total sales.

The primary causes of Inventory Shrinkage are as follows: 

Vendor Fraud

In organizations with complicated supply chains, inventory is sometimes managed directly by suppliers and vendors which are external parties that are not directly affiliated with the firm. Theft might happen while the items are loaded or unloaded while being transported from the supplier’s storage units to the business premises. Deliveries should be monitored and documented each time they enter or depart from the business premises as pilferage can easily occur, especially if the inventory is not being monitored by the business directly.

Administrative and Paperwork Errors

Even though most firms have switched from paper and spreadsheets to more advanced digital record-keeping, administrative and paperwork mistakes remain one of the biggest causes of shrinkage.

Pricing errors, unintentional reorders, missing or extra zeros, and decimal point omissions are all examples of administrative errors that can occur even on digital systems if they are not entered properly initially. Even if the organization relies on automated systems, inventory should be physically tallied and re-counted to reduce mistakes.

Damage

Anything that causes the inventory to become unsellable and not be in the same condition that it left the manufacturing line is referred to as damage. This covers things like shattered packaging, splits, rips, and water damage, among other things. Often, the inventory can be damaged while in transit. Products also suffer damage when they expire. If any of these incidents occur, sellers are forced to either sell what was once a perfectly serviceable good as a refurbished product or if the damage is severe, there are chances that it needs to be scrapped entirely, which means that the seller has incurred the expense of producing that unit but cannot recover the amount by selling it.

Human Error

Miscounting, inaccurate measurement units and improper portioning of food, drinks, and other types of inventory are all examples of typical human mistakes that lead to inventory shrinkage. Employees may store items inappropriately by mistake, resulting in waste or harm. This can even occur with advanced inventory management software in place if the person who is entering the numbers makes a mistake. This leads to confusion further down the supply chain and can have an impact on order fulfillment.

Waste and Spoilage

Although not all of the products that are damaged are discarded, some of them are perishable and once they are expired or spoiled, they can never be recovered. Perishable commodities include health care, food, dairy, medication, and various other categories of inventory. When a product is not sold before its expiration date, it goes to waste. Because you cannot sell expired products, the expense is accounted for as inventory shrinkage and it results in a loss for the business.

Theft

Employees must not only protect the business from inventory shrinkage but from other dishonest employees that might steal from the company. Employees may steal some of the company stock to make up for issues related to underpayment, lack of appreciation, or undervaluation they believe they are receiving. They may be able to rapidly conceal inventory theft since they are corporate insiders that know the inner workings of every operation.

When one item vanishes from a large supply of over a thousand products, the employer is likely unconcerned and the incident goes unnoticed until inventory is counted. Instead, the employer/accountant will believe that the merchandise went missing due to administrative mistakes when packaging or loading products onto a vehicle and will mark it as such.

Impacts of Inventory Shrinkage

Loss of Money

Profit margins are eroded as a result of shrinkage. Whenever an incident of theft, damage, miscounting, or other factors that lead to inventory shrinkage occurs, the business loses out on the opportunity to generate revenue and cash from those items. It also impacts your earnings because you must absorb the price of acquiring the items while making no profit on that item in return. Because retailers rely on thin margins to stay competitive, any event affecting profitability will likely have a negative impact.

Loss of Inventory

Buying items for your business and having a few of them stolen or damaged is an inexplicable feeling. Companies that lose things owing to inventory shrinkage can never retrieve them. This could occur in multiple ways whether it is employees or delivery personnel stealing unnoticed items, goods being damaged due to human error or while in transit or there is a miscommunication while counting inventory. Every unit of inventory is valuable for a business because it is the means by which they recover their expenditure and if any of it is unaccounted for, the business loses out on that revenue.

Miscalculations in Tax and Accounting

Missing goods due to shrinkage may result in miscalculations in accounting procedures. Audit and tax issues might arise when accounting books are not aligned, which could have dire financial and legal consequences for the business. Thus, if you have inventory shrinkage issues, be cautious with your accounting books and ensure that they tally.

Preventative Measures for Inventory Shrinkage

Though inventory shrinkage in retail is a persistent problem, it can be curbed and dealt with in several ways. Irrespective of whether you have a warehouse or your own store, any combination of these measures below may be effective in reducing inventory shrinkage

Use Inventory Tracking

It is not difficult to track products. Tracking your inventory can help determine whether a piece of merchandise has vanished from the warehouse or the retail floor and due to what reasons. There are several methods for keeping track of your inventory.

  • You can begin by labelling each product with a tagging system. 
  • You can follow the movement of any product by using this method, even if you are not physically present.
  • RFIDs are another option that can aid in decreasing shrinkage due to theft. 
  • RFID tags are becoming increasingly popular because they allow businesses to track goods as they move about the store and even trigger an alert when they leave the premises. 

Have Periodic Counts of Inventory

A periodic count of inventory can help you keep track of your stocks on a routine basis to save time. 

  • Instead of using Excel, which is standalone and not synchronized to anything, it is advisable to employ techniques such as inventory management software, that can maintain inventory counts which are updated in real-time.
  • You might use inventory cycle counts to do this. Inventory cycle counting is a method of having your pickers perform inventory counts on segments of your stock on a regular basis.
  • It is frequently associated with the use of a barcode inventory system.
  • It allows you to keep a more precise stock count at all times.

Conduct Audits

If you conduct periodic inventory audits, your employees will understand the importance of inventory to the company’s profitability and bottom line.

  • Management might perform inventory audits on smaller amounts of merchandise more often, sometimes on a daily basis, to keep personnel on their toes. 
  • This form of audit is known as “cycle counting” and is an excellent approach to daily tracking of inventory.
  • You can also use accounting to compare the amount of available stock at your physical location to the amount of stock recorded in your accounting system. This process is known as stocktaking and ensures that the physical inventory count and the accounting records are in sync. This sort of audit does not have a specific time frame.

Use Strict Security Measures

A robust surveillance program can help reduce inventory shrinkage while also assisting with inventory audits. 

  • Try installing and positioning surveillance cameras around all of your stock locations.
  • The theft warning signs will assist you in reducing inventory shrinkage.
  • The most comprehensive security for your inventory stockpiles is CCTV and warning indicators.
  • You will have a complete awareness of what’s going on in your shop if you use video monitoring. 
  • You may also identify who stole from your business using video recordings, giving authorities a place to start their investigation in case of any theft. 
  •  Since your employees know that they are being watched and tracked, they will be less inclined to steal if you install video surveillance.

Divide Responsibilities

If one person has access to receipt recording and processing, they may feel compelled to falsify the reports for their own personal gain. 

  • You may avoid this by delegating receipt recording and processing to various staff or at the very least, for quality control purposes.
  • By doing this, you can spread the responsibility as well as the accountability for proper inventory management to minimize inventory shrinkage.

Make Employees Aware

Employees may be unaware of the consequences of inventory shrinkage in retail. They must understand that a minor mistake or error can have a significant financial impact which may also impact their pockets if the business goes under.

  • Use this as your chance to explain how shrinkage impacts them, both directly and indirectly, such as how it reduces promotions, salaries, and employee profit-sharing, among other things.
  • However, as an employer, you are responsible for providing them with the tools they require to reduce mistakes and carelessness.
  • This entails having simple inventory systems that don’t need much technical expertise to learn. You can then provide general training and offer sufficient onboarding for new employees.

Partner With a 3PL

Third-party or 3PL logistics companies assist eCommerce businesses by storing goods in the various fulfillment centers, picking and packing procedures, and shipping orders.

  • They have the resources to keep your goods safe and secure while allowing you to outsource fulfillment, which may be costly and inefficient to operate in-house.
  • Most 3PLs offer comprehensive information and technology to assist you in keeping track of stock levels and reducing inventory shrinkage.
  • Small and medium-sized businesses often do not have access to such advanced infrastructure so employing can instantly limit errors and reduce inventory shrinkage.

Conclusion: How Can 3PL Companies Like WareIQ Minimise Inventory Shrinkage?

Inventory shrinkage may be eroding your revenues without your knowledge. It can have several negative consequences for your company and may impact the relationships between your company and suppliers and also between members of your team. Hence, it is essential to prevent inventory shrinkage to the maximum extent possible. To that end, you can utilize the services of 3PLs such as WareIQ, which offer several professional services like inventory management and order tracking, to ensure that you are constantly aware of your stock flow which is especially useful for companies that are expanding and are finding it difficult to manage eCommerce operations on their own.

inventory shrinkage_Inventory Planner

WareIQ is a burgeoning eCommerce platform that uses highly advanced technology to provide solutions to every eCommerce requirement that retailers have. A few of the services we offer include:

  • We can assist in managing your inventory turnover rate and lowering your inventory carrying expenses to save money for your company.
  • We employ various tactics to limit problems such as inventory shrinkage. As a result, if you outsource your fulfillment operations to us, you will be able to minimize your inventory shrinkage and maximize your profits.
  • We offer services such as an RTO Shield, NDR, and an app store to enhance the productivity of your business.
  • We have a state-of-the-art WMS that can keep track of your inventory across multiple platforms and fulfillment centers to prevent inventory shrinkage and can also integrate with multiple eCommerce selling platforms.

Inventory Shrinkage: FAQs