More money, they say, equals more issues.
The same may be said for inventory control. The more inventory goes in and out for your business—the more people, warehouse space, customers, orders, and returns—the more likely stock items will be misplaced, damaged, or stolen.
To put it in simple terms, it’s called inventory shrinkage.
At first, the shrinkage cost may appear insignificant, and it may be written off as a cost of doing business. However, it will snowball over time, causing a constant headache that will obstruct long-term, healthy growth and scalability—particularly in the retail world.
Here’s a closer look at recognizing inventory shrinkage and reducing it.
- What is inventory?
- What is inventory shrinkage?
- How to calculate inventory shrinkage: formula
- Causes of inventory shrinkage
- 7 Ways to reduce inventory shrinkage
- What happens if inventory shrinkage goes unnoticed?
- How can your third-party logistics provider assist you in preventing inventory loss?
What is Inventory?
Inventory is referred to the goods that a company buys or makes intending to sell. A company must invest a certain amount of money to purchase these goods.
Several businesses purchase things to resell them and make a profit. They’re called inventory-supplied businesses.
Inventory shrinkage is a common problem for firms. But what exactly is this loss? Let’s take a closer look.
What is Inventory Shrinkage?
Inventory shrinkage definition in accounting describes when a company has fewer products in stock than are indicated on the inventory record. It’s a typical problem that impacts most retailers’ profits and results in revenue loss.
When inventory shrinkage is high, it may suggest that a company is experiencing underlying issues. To reverse and avoid shrinkage, accounting professionals may need to analyze financial statements and revenue accounts, and management may need to assess sales team practices.
In most cases, inventory shrinkage should be less than 1% of total inventory.
How to Calculate Inventory Shrinkage: Formula
The steps for calculating the inventory shrinkage formula are as follows:
Step 1 – Locate the inventory that has been recorded
This is the inventory available at the start of the sales process.
This would be your recorded inventory, for example, if you logged 534 boxes of fruit when stocks arrived.
Step 2 – Count the actual stock on the shelf
This is the number of products available in your store.
Continuing with the cartons of fruit example, your inventory is 500 boxes after reviewing your stock.
Step 3 – Determine the amount of inventory that will be lost due to shrinking
Use the following formula to calculate inventory shrinkage:
Inventory shrinkage = Recorded inventory – Actual inventory
Using the fruit inventory as an inventory shrinkage example:
534 boxes were counted in the inventory.
The actual stock is 500 boxes.
534 − 500 = 34
34 crates of inventory were lost due to shrinkage.
Step 4 – Determine the rate of shrinking
Use the following formula to compute the inventory shrinkage rate:
Shrinkage rate = Inventory shrinkage / Recorded inventory
To calculate the rate of fruit inventory shrinking, use the following formula:
534 boxes were counted in the inventory.
Therefore, 34 crates of inventory were lost due to shrinkage.
34 out of 534
Shrinkage rate = 0.06367 (about 6.4%)
This is regarded as a high rate of inventory shrinkage. Inventory shrinkage is unavoidable for perishable goods. To avoid such losses, it’s critical to regularly check your goods and accounting records.
Causes of Inventory Shrinkage
Let’s take a step back and fully comprehend the problem before moving on to the solution. Inventory shrinkage occurs for a variety of causes. Here are a few examples:
Inventory shrinkage is caused by various factors, the most common of which is theft. When shrinkage happens, a large company should be able to hold someone accountable. Unfortunately, a small business frequently fails to hold someone responsible. The following are the most common thefts:
Theft by Consumers
This type of stealing is known as shoplifting. Shoplifting can be difficult in huge physical establishments. However, it is not commonly found at small-scale retailers or outlets. The items come in small packages that are easy to smuggle inside a bag or beneath clothing. As a result, usually, the large goods are saved.
Employee Identity Theft
Employee theft contributes to the company’s or business’s inventory shrinkage. This is because personnel are in close contact with the inventory and can exploit security flaws (at warehouses/stores). It may be difficult, but it is not impossible to get out of this circumstance.
Error in Administration
Administrative errors indicate that inventory shrinkage appears in the books due to an administrative error. For example, this could be due to incorrect data entry, cash-counting problems, or incorrect sales recording.
Damages make it impossible to sell a thing. Water damage, fracture, and cracking are all examples of damage. This forces the company to suffer inventory shrinkage due to the loss.
Several products are thrown due to damage. Perishable commodities include health care, food, dairy, medications, etc. If a product is not sold before its expiration date, it becomes a waste. The company cannot sell this, so the shrinkage cost is factored towards inventory shrinkage.
A variety of factors can cause inventory shrinkage. Some appear inescapable. The scope of lowering the attitude of carelessness can reverse the wheel and reduce inventory shrinkage.
7 Ways to Reduce Inventory Shrinkage
Inventory shrinkage is a business notion that can be overcome with the correct measures. However, some firms may not be aware that they can lessen the additional loss they are experiencing.
As a result, now is the moment for them to grasp the concept. The good news is that we have various options for reversing the inventory decline. We’ve outlined seven effective strategies to change the procedure to ensure that the inventory is safe on the premises.
Checking for Security
When it comes to inventory, security checks should be a non-negotiable idea. CCTV cameras should be installed around the warehouse or retail shop. If the products are limited in quantity, they can be tagged with tracking devices.
Locked cupboards can be used to store groceries and small items. Anti-theft alarms, as well as a manual screening process can be installed at the security check. The company will be protected from inventory theft as a result of this.
Implementation of SKUs and Barcodes
Each product is identified by its SKU and barcode. It becomes a lot easier to maintain track of the items’ liquidity. It also aids in determining which product is in higher demand than others.
Double-Check of Responsibilities
Another technique to ensure inventory safety is to assign cross-checking responsibilities to personnel. For example, assign two staff to keep an eye on the inventory, prepare reports, analyze them, and compare them regularly.
Regular Inventory Audits
Employees that have direct access to the inventory may commit fraud or make mistakes, but an outsider will not. Therefore, bring in a supervisor regularly to conduct inventory audits. This will ensure thorough inventory bookkeeping, resulting in tight security and reduced staff theft.
Automated Inventory Management
The corporation can reduce its reliance on manual labor by using an automated inventory system. It will also expedite inventory counts, cash management, and better visibility into holdings.
Regular Inventory Level Checks
Periodic inventory checks enable a company to estimate inventory-related losses and expenses.
The technique can aid in making a comparison of losses that occurred over time and differences after each check by keeping records. In the long run, it will aid in the reduction of inventory shrinkage.
One role should be designated as the inventory’s responsible recruitment. After that, the individual hired for the job should undergo extensive training.
Employees should be judged not just on their abilities but also on their moral character. The company can then hold one person responsible for inventory shrinkage, if found guilty and correct the problem in the long run.
What Happens if Inventory Shrinkage Goes Unnoticed?
Inventory accounting is a crucial job for business owners. The following are the most significant consequences of unnoticed inventory shrinkage:
Product loss: Inventory shrinkage can cause products to be misplaced or stolen.
Reduced revenue and profit: Shrinkage reduces the number of products available for sale, lowering revenue and affecting business expenses such as employment, inventory management, and shipping costs.
Accounting and tax errors: If your company intends to sell a certain amount of products, but shrinkage makes that impossible, your financial records may be incorrect.
Additional resource costs: Reconciling inventory shrinkage and determining the sources of loss takes time. You may need to hire outside auditors to double-check your receipts and accounting records.
How can your Third-Party Logistics Provider Assist you in Preventing Inventory Loss?
Shrinkage limits will be minimal or non-existent at the best fulfillment services providers such as Pickrr. As a result, outsourcing your fulfillment operations may allow you to lower your shrinkage rate. It’s possible that entrusting your order fulfillment to pros will save you money.
Finally, we can all agree that inventory shrinkage is a serious problem that necessitates a thorough examination of your business operations and the identification of associated flaws. Once they’ve been determined, you can adopt the best option for reducing inventory shrinkage.
It’s not easy to cut losses and keep them to a minimum. It requires commitment and consistent attention, which must begin before an applicant is hired and continue throughout each business day.
An effective loss prevention program will eliminate, or at the very least considerably decrease, those possibilities.