Inventory shrinkage is a scenario that most businesses have experienced at some point in time. It refers to a case when the amount of inventory shown in the accounting records does not match the actual records. Since it is important to maintain optimum inventory at all times, you must track and prevent inventory shrinkage diligently. In this article, you will understand inventory shrinkage in detail along with different types of inventory shrinkage, causes of inventory shrinkage, prevention of inventory shrinkage as well as solutions.
Understanding Inventory Shrinkage
Inventory shrinkage is a business scenario wherein there is a mismatch between the inventory list and actual products in stock. A nominal amount of shrinkage is normal for every business because you need to have some room for unforeseen losses, losses due to damage to goods in transportation, and several other reasons that we have discussed below. But when the shrinkage becomes noticeably larger, then you must surely investigate it without delay and see how it can be prevented in the future.
Different Types of Inventory Shrinkage
There are many types of inventory shrinkage which every owner or business must be aware of.
Inventory shrinkage at the manufacturer's end:
If the manufacturing process is not carried out in a streamlined manner due to a lack of raw material, labor issues, or any other reason, it results in inventory shrinkage. So, shrinkage of inventory at a manufacturer's end means that the manufacturing process is slowed down due to certain reasons.
Inventory shrinkage at the vendor's end:
Sometimes the vendor is not efficient and delivers poor-quality goods or the inventory ends up getting damaged fully or partially in transit. If timely action is not taken such inventory shrinkage will continue.
Inventory shrinkage at the retailer's end:
This type of inventory shrinkage happens at the retailer's end due to several reasons like internal theft, external theft, or shoplifting.
Inventory shrinkage due to the nature of the industry:
In some industries like restaurants and hospitality, there is shrinkage mainly due to the expiration of raw materials or spoilage.
- Statistics and Costs Associated With Inventory Shrinkage
The average inventory shrinkage rate varies from one industry to another. According to experts, the ideal inventory shrinkage rate should be 1% or 2%. The lesser the better and for that the causes must be understood, and preventive measures must be taken on time.
Calculating the cost of inventory shrinkage is quite simple, it is the value of missing inventory. Let's assume you ordered 100 items worth Rs. 1000 each but received just 95 due to theft or breakage of 5 items during transit. Here shrinkage of inventory is 5 units with a value of 5x1000 i.e. Rs 5000. To calculate shrinkage in percentage, Rs. 5000 is divided by 100,000 multiplied by 100 which comes to 5%.
In terms of costs associated with inventory shrinkage, warehouse costs (in case of theft), logistics costs (if lost or damaged in transit), and labor costs among others, are included.
Causes of Inventory Shrinkage
There are many causes of inventory shrinkage. They may be internal or external causes. Listed below are the most common causes of shrinkage:
- Shoplifting or theft - This can happen at any time in the supply chain. It happens internally when employees steal or externally when there are incidents of shoplifting.
- Spoilage - This happens in restaurants, food and beverage industries, and grocery stores. All raw materials or finished goods that get spoilt are thrown away accounting for shrinkage.
- Human mistakes and accidents - Humans are prone to mistakes that lead to damage and inventory loss. Clerical errors in recording inventory may wrongly show inventory shrinkage. Sometimes damage is caused to goods in transit.
- Vendor fraud - Sometimes fake vendors pose as real vendors, accept the payment but don't deliver goods resulting in shrinkage of inventory. Though this is rare. Also, sometimes the vendor may charge higher or additional fees or taxes which are not valid.
- Common Indicators of Inventory Shrinkage
Some indicators of inventory shrinkage are:
- Untrained or inefficient staff
- Unorganized inventory
- Operational inefficiency
- Poor merchandising practices
- Cluttered and untidy stores
- No inventory tracking mechanism
- Zero security or poor security
Prevention of Inventory Shrinkage
Prevention of inventory shrinkage is possible if correct measures are taken. Let's look at how this can be done:
- Employee Training and Education:
Employee training, awareness, and incentives can play a key role in shrinkage reduction. Train your employees to stay alert, on how to use inventory tracking tools, and how to deal with situations when they notice any theft.
- Inventory Management Software:
Use barcode inventory software for tracking inventory efficiently and monitoring inventory levels. You can also use Radio-Frequency IDentification (RFID) tags.
- Security Measures:
Tighten the security measures if you have a warehouse or a retail store by installing CCTV cameras, intruder detection, door locking systems, restricted access control, and deploying security guards. These will also help to identify people who are responsible for theft.
- Auditing and Tracking Systems:
Auditing and tracking measures will give you a fair idea of your inventory. Install the latest item tracking systems to prevent inventory loss while also conducting a physical count of the inventory from time to time.
Solutions to Inventory Shrinkage
You can control inventory shrinkage by proper investigation and detection of causes. This can be done by ensuring regular inspections using inventory control staff, inventory control systems, and other such modern tools and gadgets.
Another way to reduce inventory shrinkage is to conduct double-checks on the inventory and rotate the products in the warehouse. Employees in charge of inventory management must be held responsible for inventory theft and trained to be alert and aware and perform regular checks. By rolling out incentives for high-quality inventory monitoring, you can promote an inventory loss prevention culture.
Adopt the Best Inventory Software to Prevent Inventory Shrinkage
Implementing the best inventory management software could help you ensure the least inventory shrinkage and prevent inventory losses. TranZact's inventory management system includes a feature-rich inventory dashboard that offers a complete view of stock at a single glance.
Ideal for Indian manufacturing SMEs, this cloud-based stock management system helps to track inventories in real-time so that there is no overstocking or under-stocking and you can make informed decisions quickly. It provides you with live insights needed to prevent inventory shrinkage by enabling regular inventory supervision and real-time stock management!
FAQs of Inventory Shrinkage
1. What are acceptable levels of inventory shrinkage?
Acceptable levels of inventory shrinkage may vary from industry to industry and from business to business. Enterprises operating on a larger scale can naturally tolerate high levels of shrinkage while it is the reverse with small industries. Ideally, inventory shrinkage must not be more than 2%.
2. Does shrinkage affect the business?
Yes, inventory shrinkage does affect businesses significantly. It could lead to an increase in product prices to make up for the losses. This may lead to the loss of customers.
3. What are the common causes of inventory shrinkage?
The most common causes of inventory shrinkage are internal and external theft, spoilage, errors, fraud by vendors, and other material defects.
