Inventory shrinkage is a serious issue for businesses of all sizes. This type of loss can be attributed to a variety of factors, but the main culprit is theft. Theft comes in many forms, such as employee theft, shoplifting, and fraudulent returns. In addition to theft, inventory shrinkage can be caused by inaccurate inventory records, damaged goods, or clerical errors. Each of these causes of inventory shrinkage can lead to a decrease in profits and a decrease in customer satisfaction. It is essential that companies take proactive steps to prevent and reduce inventory shrinkage in order to protect profits, ensure customer satisfaction, and maintain a professional reputation. In this blog post, we will discuss strategies for managing and minimizing inventory shrinkage. We will look at how to identify the root causes of inventory shrinkage, strategies for minimizing it, and how to put systems in place to ensure it does not happen again.
Financial Accounting – Lesson 6.5 – Shrinkage – Inventory
How to calculate inventory shrinkage: formula
Here are the steps for calculating inventory shrinkage:
1. Find the recorded inventory
This is the initial stock from when the sales process first began. This is your recorded inventory, for instance, if you recorded 534 boxes of fruit when the stocks arrived.
2. Count actual inventory on the shelf
This is the actual number of products in your store. Keeping with the fruit box example, if your inventory shows 500 boxes after checking, this is your actual inventory.
3. Calculate inventory shrinkage
To calculate inventory shrinkage, use this formula:
Inventory shrinkage = Recorded inventory – Actual inventory
Example: Using the fruit inventory example:
4. Calculate the shrinkage rate
To calculate the inventory shrinkage rate, use this formula:
Shrinkage rate = Inventory shrinkage / Recorded inventory
Example: To find the fruit inventory shrinkage rate:
This is considered a high inventory shrinkage rate. For perishable goods, inventory shrinkage is unavoidable. Regularly checking your inventory and accounting records is essential to preventing such losses.
What is inventory shrinkage?
When inventory shrinkage is high, it may be a sign that there are underlying issues with the company. To stop and prevent shrinkage, management may need to evaluate the sales team’s processes and have accounting professionals review financial statements and revenue accounts.
Typically, the shrinkage of your inventory should be less than 1% of inventory.
Causes of inventory shrinkage
The following are a few of the most typical causes of inventory shrinkage:
Waste and spoilage
Inventory shrinkage may result if perishable goods are not consumed or purchased prior to their expiration date. For instance, inventory is lost and shrinkage is considered if you have fruits in stock when their expiration dates have passed. The food and beverage industries are primarily affected by waste and spoilage.
Damage
When products become unusable due to unforeseen issues or accidents, damage has occurred. For instance, when a box of fruit spills and damages itself on the stockroom floor, shrinkage increases. However, the product doesnt have to be a perishable item. It falls under the category of damaged products if it is too damaged to be sold. A computer that was harmed during shipping and no longer functions as intended serves as an illustration.
Inventory shrinkage may also be accounted for by goods returned due to damage. Returns are a significant contributor to damage-based shrinkage in the retail industry.
Theft
There are two main ways that theft frequently happens: externally, like shoplifting, and internally, like when an employee steals from the business. At the point of sale (POS), where staff members can use POS systems to change inventory numbers, internal thefts frequently take place. Inventory shrinkage is primarily caused by employee theft and shoplifting in many industries.
Human error
All levels of a business—from top management through the accounting division to the warehouse—are susceptible to human error. Inventory shrinkage is frequently caused by human error, including inaccurate counting, the use of the wrong units of measurement, and improper food and beverage portioning. A worker may unintentionally store goods incorrectly, which could lead to waste or damage.
Administrative and paperwork errors continue to be a significant contributor to inventory shrinkage, despite the fact that most businesses have switched to keeping digital records rather than paper ones. Pricing mistakes, unintentional reorders, additional or deleted zeros, or missing decimal points are some examples of administrative human errors.
Vendor fraud
5 ways to prevent inventory shrinkage
You can combine any number of prevention techniques depending on your place of employment. Here are several practical ways to prevent inventory shrinkage:
1. Install tracking devices
You can hardwire delivery trucks, put plug-in gadgets on delivery cars, or put a tracker on a package of goods or a single, expensive item. You can use this to find out when a product vanishes from a warehouse or retail shelf.
2. Invest in security
3. Count inventory often
Regularly check inventory counts to minimize errors, quickly identify problems, and prevent internal theft You can also make an investment in technology to increase the efficiency of inventory counting and recording.
4. Perform unscheduled audits
Perform audits without letting team members know if you have any suspicions that shrinkage may be caused by internal theft or human error. Because employees aren’t given enough time to fix any discrepancies in your inventory, this can help you develop a more realistic understanding of the shrinkage problem.
5. Split responsibilities
Changing roles and dividing responsibilities over time can assist you in finding mistakes in your financial records. Employees can therefore hold one another accountable for processing and recording receipts, monitoring and managing inventory, and developing procedures that prevent all forms of shrinkage. For quality control, you can delegate the recording and processing of receipts to various employees at various times.
What happens if inventory shrinkage goes unnoticed?
Accounting for inventory is an essential responsibility for business owners. Here are the major effects of unnoticed inventory shrinkage:
FAQ
What are 3 main causes of shrinkage?
Shrinkage is primarily brought on by four factors: employee theft, shoplifting, mistakes in administration, and fraud.
Is inventory shrinkage an expense?
Inventory shrinkage is considered an expense. The amount you’re reporting often determines how you record it in your books. A debit to the cost of goods sold expense account and a matching credit to the relevant inventory asset account, for instance, can be used to record small, periodic write-downs.
How can shrinkage affect an inventory system?
Inventory shrinkage is the difference between the amount of inventory that is actually on hand and the amount that is recorded in your books. Loss of goods as a result of a variety of factors, including theft, natural disasters, or administrative mistakes This physical loss directly affects your profits.
