Inventory Shrinkage: Definition, Causes & How to Prevent It

What Is Inventory Shrinkage?

Inventory shrinkage is recorded when a product’s listed quantity-on-hand exceeds the actual physical count. The difference between these two amounts is referred to as “shrink.” In a retail setting, this is sometimes called retail shrink; and in a warehouse or manufacturing business, it’s generally reported as inventory shrinkage. Either way, it means the same thing—you’re missing inventory you thought you had.

For example, if a retailer’s POS system inventory count shows an expected quantity of 69 units, but only 68 are located in a physical count, the missing unit is considered “inventory shrinkage.”

When your recorded and physical stock counts don’t match it’s called inventory shrinkage. The loss can be real like shoplifting theft or just a clerical error like a typo during receiving.

Unfortunately, inventory shrinkage is rampant. The 2020 National Retail Security Survey found retail shrink is at an all-time high. Approximately 70% of retailers have a shrink rate higher than 1%. In 2019 alone, this cost the industry $61.7 billion.

According to retail consultants Rich Kizer and Georganne Bender of Kizer & Bender:

“No question, a POS system is a must-have tool to quickly spot and remedy inventory shrink. Physical cycle counts taken at shelf level are also necessary because they are the comparison of actual inventory to what the POS system reports. If reported inventory numbers and physical counts don’t balance something is going on. Sloppy merchandising? Shoplifters? It’s important to spot it fast, then quickly get to the bottom of it.”

Since many POS systems such as Square POS, can adjust stock counts in real time as sales, returns, and stock receipts occur, recorded and physical counts should always match. “The use of real-time POS inventory reports is mandatory,” say Kizer and Bender. “They help retailers uncover inventory shrinkage issues before they become costly headaches.”

When the numbers don’t match, two things need to happen:

1. Inventory counts must be adjusted to reflect the actual quantities on hand and the adjustment mirrored as inventory shrinkage in the store’s bookkeeping system.
2. The store owner and staff need to identify the root cause of the shrink—theft, stock mismanagement, checkout errors, or unreported damages are all common culprits.

Whenever inventory shrink occurs, it’s important to look deeper to determine if it’s a unique occurrence or part of a larger trend. A single occurrence should be noted and watched, but If the investigation points to a trend, retailers must quickly put remedies in place to prevent further losses.

How to Calculate Inventory Shrinkage

Like we mentioned above, inventory shrinkage is the difference between the amount of stock you think you have and the amount of stock you actually have in reality. But you can’t physically count all of your stock every time you want to know how much shrink to account for.

Instead, small businesses can use a few calculations.

First, you can calculate inventory shrink through POS analytics and a physical count. The formula for inventory shrink is:

Recorded inventory comes from your POS data, while physical counts give you actual inventory metrics.

The formula for inventory shrink rate goes like this:

Now let’s put the formula to work with an example. Your retail business has $50,000 of inventory listed in your POS and inventory management system. This is your recorded inventory. You and your team conduct a physical count and find $40,000 of stock on hand. This is your actual inventory.

Inventory Shrinkage = $50,000 – $40,000 = $10,000

So you’ve lost $10,000 worth of inventory to shrink. Now let’s calculate the shrink rate, which is helpful in applying trends, forecasting, and benchmarking:

Inventory Shrink Rate = (($50,000 – $40,000) / $50,000) * 100 = ($10,000 / $50,000) * 100 = 20

This means your inventory shrink rate is 20%. Therefore, if you don’t do anything, you can expect to continue to lose 20% of your inventory investment to shrinkage. If you do take steps to mitigate inventory shrinkage, then this is a metric you’ll want to use. Percentages are more accurate when comparing and forecasting with data sets.

Download our Free Inventory Management Workbook to track product counts and calculate inventory shrink.

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What Causes Inventory Shrinkage?

Customer theft, employee theft, and clerical and administrative errors are three of the top causes of shrink across all types and sizes of retail operations.

Here’s a closer look at each of these leading causes of inventory shrinkage:

1. Retail Shrink Due to Customer Theft

Customer theft might be the first culprit you think of when it comes to retail shrink. Shoplifters take advantage of vulnerable and unobserved areas in your store. The spaces between aisles and racks and dressing rooms are a few ideal places to do their dirty work.

Businesses that sell high-value, high-demand products are also often targeted by shoplifters. For example, when I managed retail spas, aestheticians had to put away products after finishing treatments and before leaving the room. Before we started that practice, it was common for customers to slip skincare products into their purses or pockets when redressing after a treatment.

And unfortunately, thieves are getting more sophisticated in their tactics. In fact, organized retail crime is on the rise—the NRF found that 97% of businesses have fallen victim to it. Retailers should have prevention tools like a solid POS system, security mirrors, and staff awareness training in place from day one.

According to Kizer & Bender, your staff can unintentionally contribute to external theft too:

“Sales associates busy shelving or organizing products in lieu of working with customers are accidents waiting to happen. Shoppers expecting service walk out with nothing except frustration and—far too often—shoplifters find an easy mark.”

Tag swapping is another pervasive form of retail shrink that directly affects inventory numbers and profits. Tag-swappers place a lower-priced item’s tag on a higher-priced product and then complete the purchase. This hides the theft initially, but it throws inventory numbers off for both goods. Unfortunately, most retailers detect this during stock counts, long after the fact.

Other types of customer theft, like coupon scams, affect your profits and bottom line but aren’t revealed as missing units. You can spot this type of loss by examining sales figures and discount reports—this is where using the best POS system really comes in handy.

2. Retail Shrink Due to Employee Theft

According to the NRF, dishonest employees are more common than you would hope. In fact, 2019 saw more employee apprehensions, terminations, prosecutions, and civil demands than the year prior.

One study focused on college students in the workforce—workers who often seek out retail jobs—and the results are equally concerning, if not more. Most respondents admitted to stealing something from their employers, including property.

And unfortunately, internal theft can be very difficult to spot and remedy. Since employees have access to extended areas of the store and know sales and inventory control processes, it’s easy for untrustworthy staff to steal goods under the radar. Marking sellable goods as damaged, stock receipt miscounts, sliding items to friends during checkout, and applying excessive discounts are some of the ways internal theft takes form.

A POS system that supports assigned staff logins and system restrictions gives store owners the advantage by limiting staff access to key data and tracking all system activity to staff-specific user IDs. Square, Lightspeed, and ShopKeep by Lightspeed all offer some form of this, for example.

3. Retail Shrink Due to Clerical and Stock Control Errors

You can use modern POS technology to mitigate inventory control and clerical errors, but mistakes are inevitable. Luckily, these problems can be the easiest to identify and solve.

Some are simple miscounts that aren’t connected to actual physical losses. Others can be costly, like recording all of the goods in a supplier shipment as received-in-full when some items were actually missing from the shipment.

“Some shrink issues are little more than an inconvenience,” says Sarah Curtis, shop manager and assistant buyer for North Standard Trading Post in Toronto. “Often, the major discrepancies are accounted to human error, like items being mistagged and products on sales transactions not getting rung up properly.” In these cases, goods aren’t actually missing, but those errors can lead to bad record keeping: inaccurate counts, improperly timed reorders, and lost time investigating and correcting the issue.

“We do a large hands-on, full inventory count of our whole business annually and this is where we catch any shrinkage,” says Curtis. “[We] compare our current active inventory against our physical counts to make sure the numbers match. If they don’t, we can make adjustments accordingly, then investigate further if needed.”

How to Minimize & Prevent Inventory Shrinkage

Even though theft is a top cause of inventory shrinkage, tight inventory control is your first line of defense. Without accurate inventory numbers and effective inventory management processes, chances are you’ll never spot shrink issues in the first place. Once any clerical and receiving problems are remedied, you’re set to spot and combat theft-related retail shrink with training, monitoring, and visible deterrents.

Here are ways to minimize and prevent all three types of inventory shrink that you’ll encounter at some point in your retail operation.

Prevent Retail Shrink From Inventory Control and Clerical Errors

Clerical and stock-keeping errors might be common but they’re also typically the easiest problems to fix. It’s often simply a matter of improved stock receiving, counting, and tracking procedures. Since accurate stock counts are key to spotting theft-related shrink quickly, fine-tuning store processes and systems should be the first task on your list.

Here are seven ways to remedy retail shrink issues caused by clerical and inventory control errors:

1. Implement Inventory Management Procedures

Establishing a sound inventory management process is the first step in preventing inventory shrinkage due to clerical and stock control errors. Inventory management procedures are easy to implement and ensure that stock receipts, cycle counts, and damage tracking are all handled correctly.

2. Use a Retail POS System With Advanced Inventory Features

Pairing good inventory management procedures with a feature-packed POS system is the best way to combat shrink from stock management, clerical, and checkout errors. Powerful inventory control tools like real-time inventory adjustments per-sale, automated receiving, bar code scans at checkout, and detailed sales and inventory reporting, all minimize errors and help retailers quickly spot shrink when it occurs.

Inventory and line-item sales reports in POS systems help retailers spot stock mismanagement and sales-related inventory shrinkage issues. For a retail POS tool with strong inventory management features, check out Lightspeed or ShopKeep by Lightspeed.

3. Conduct Regular Cycle Counts

Cycle counts are partial stock counts conducted regularly to spot retail shrink and other stock control issues like misplaced or mistagged stock. Unlike annual counts which require preparations and dedicated time to complete, cycle counts are small spot-checks of stock that you can use to check stock count accuracy, catch shrink, and make necessary adjustments.

4. Use Bar Code Labels to Prevent Checkout Errors

Scanning bar code labels or SKU numbers at checkout reduces sales entry errors, plus it speeds up your checkout process tremendously. As long as your products are properly tagged, bar code scanning virtually eliminates mistyped item codes and prices at checkout, keeps your sales and inventory counts accurate, and cuts retail shrink. Bar codes also speed up cycle counts and stock lookups for stock control checks, especially if you use a mPOS with cycle count functionality.

5. Use First-In, First-Out (FIFO) Inventory Management

First-in, first-out inventory management, known as FIFO, dictates that you sell older stock first. It’s very important in stores that sell products that spoil or have expiration dates like food, personal care, and cosmetics. Even if you don’t sell goods that expire, FIFO is good to follow since packaging changes and fades over time and goods that sit around for too long tend to look old. FIFO methods aren’t complicated, you just shelve or store new arrivals behind older goods. Because you look a bit closer when shelving, it helps catch misplaced items and keep your stock under control.

6. Receive Stock Shipments Quickly and Accurately

Receiving stock shipments promptly and correctly helps prevent all sorts of inventory shrinkage headaches. Receiving best practices dictate that every stock shipment is carefully checked to ensure the goods shipped match what you ordered, and to catch vendor errors, shortages, and any shipping damage. Only after stock receipts are fully vetted should inventory numbers be adjusted. If not, sloppy receipts lead to inaccurate numbers, missing inventory, and payments to suppliers for stock not received.

Stock receipts automatically adjust your stock-on-hand numbers in many POS systems.

7. Remove Damaged Goods From Inventory Counts

Damaged goods are inevitable in retail. Inbound stock can suffer damages in transit, and in-store shoppers damage products and reshelf them to avoid having to pay, for instance. When you discover damage, it’s important to quickly adjust your stock count and then dispose of the item. If you don’t, your counts will be off, and the missing unit will look like a shrink issue after you’ve forgotten about the damaged goods.

8. Automate What You Can

Automation is a great way to take some of the mundanity out of repetitive tasks while also improving operational efficiency—not to mention data accuracy. When you automate certain tasks in your inventory management process, you remove some of the human error that can skew numbers and lead to clerical shrink. Tasks that are ideal for automation include receiving, daily stock reports, low stock alerts, and others. All of these tasks can be automated using a POS system like Square.

Square offers a free retail POS, and advanced plans with more robust inventory management tools. Visit Square to create a free account and start automating your inventory today.

Prevent Retail Shrink Caused by Customer Theft

Shoplifting and other forms of external theft are the leading cause of inventory shrink for all types and sizes of retailers. It’s important for retailers to first have inventory controls like accurate receiving, regular cycle counts, and a POS system in place to even spot shoplifting and other consumer theft issues. Along with using stock-control procedures and tools to spot problems, a few added deterrents help in the fight against retail shrink.

Here are five simple and inexpensive ways to send shoplifters packing.

1. Position Your Checkout Near the Entry

When planning your retail store layout, positioning your checkout near your store’s entry helps deter both grab-and-run thieves and more savvy shoplifters. If you can’t place it at the entry, make sure the checkout has a clear line of sight to the door. You can use mirrors or even cameras to do this. It’s also a good idea to train staff to greet every customer as they enter so would-be thieves know they’ve been seen—and could be described to authorities.

2. Install Obvious Video Cameras, Mirrors & Signage Throughout the Entire Store

Don’t be afraid to let customers know you’re watching them. Honest customers won’t care and dishonest thieves will be warned—and hopefully leave. Security mirrors and video cameras can be placed to cover areas that are hard to see from the checkout and other staffed areas. If you do suspect a theft, video footage can be provided to authorities, used for any insurance claims, and is even helpful as a training tool for staff. Back all of this up with a few simple sign, warning thieves they’re being watched and that you actively prosecute.

3. Securely Display Expensive Goods

Use locking display cases and place displays of high-cost goods near regularly staffed areas such as your checkout. Simple deterrents like these are very effective in stopping light-fingered shoppers.

4. Hold Bags for Customers by the Checkout

Don’t let customers browse or head into dressing rooms with large shopping bags. Offer to lighten their load by holding these for them at your checkout or other areas where you can protect them—and your products.

5. Train Staff to Watch for Theft Warning Signs

Train staff to look out for any suspicious behavior and to report it without hesitation. Have staff assist customers in the dressing rooms and pay attention to what goes in and comes out. During checkout, train clerks to spot-check that purchased purses and bags are empty and that tags are a correct match to goods. Also, teach staff to watch that customers leave wearing what they came in with—not goods from your racks.

6. Upgrade Your Technology

According to the NRF, 65% of retailers have made organized retail crime a higher priority than five years ago, with more than half pursuing additional technology solutions to help. Here’s one example: Some thieves steal merchandise and later return it for store credit issued as gift cards which they then sell for cash. In fact, more than half of retailers have found their own gift cards for sale online or at pawn shops. Look for a POS that can issue gift cards and receipts, as well as refunds—ShopKeep by Lightspeed is one great example.

7. Revisit Your Return Policy

Speaking of refunds, you might want to take a look at how you handle them if you want to reduce external theft. Nearly 40% of retailers have plans to change return policies, one way to help fight inventory shrinkage.

Prevent Retail Shrink by Deterring Employee Theft

Employee theft is frustrating and often uncomfortable to deal with. Every retail store owner eventually comes across a less-than-honest employee. But even otherwise loyal staff sometimes push the limits by stacking discounts or giving employee discounts to friends.

Here are five ways to protect your business from less-than-upstanding staff.

1. Use a POS System With Unique Staff Logins

POS systems that support unique staff logins, give retail store owners a powerful tool to prevent employee theft-related inventory shrinkage. Assigning each staff member a unique ID makes it easy to track every transaction they make. POS systems let you see detailed reports, and see which staff member handles receipts, sales, inventory adjustment, returns, and even applied coupons to sales. If shrink is uncovered, like a stock receipt that doesn’t match the vendor’s bill, you can see who logged the receipt and investigate the issue.

2. Conduct Regular Audits

With a POS system, you can pull employee login reports and review sales profitability, discounts applied, and stock adjustment activities. If anything looks amiss, you can investigate and make sure it’s not connected to theft.

3. Install Video Cameras

Don’t hesitate to use video cameras in your store’s backroom, break, storage, and receiving areas. Employees have access to many out-of-the-way spots in your store and that’s where theft generally occurs. Review footage regularly to ensure staff is not taking advantage.

4. Use Staff Checks & Balances

Stock counts and receiving tasks are opportunities for dishonest staff to steal and hide it within inventory adjustments and stock receipts. Having a two-person stock check and receiving system ensures a second person is reviewing the numbers. If you’re afraid staff might be teaming up on theft, step in yourself to make sure the numbers add up correctly.

5. Limit Access to Areas & Systems

Limiting staff access to just the systems and areas they need to get the job done is very effective in preventing retail shrink from employee theft. With a POS system, you can assign specific permissions to staff IDs that allow or disallow actions like stock adjustments, price changes, and purchase order receipts. This way, only employees that you trust can access shrink-sensitive data.

And did you know that almost three-quarters of retailers have been victims of cargo theft? More than half of instances happen en route from distribution centers to stores, with a third occurring at distribution centers and 30% in transit between stores. Therefore, it’s also a good idea to physically limit access to expensive goods and cash by locking warehouses, storage areas, offices, displays, and even vehicles—and only give trusted employees or managers keys.

6. Implement a Strong Candidate Screening Process

Retailers are proactively taking steps to find better candidates and identify red flags during the hiring phase. Increased employee screening has been adopted by more than a quarter of retailers to help fight inventory shrinkage as a result of internal theft. Run background checks, follow up with references, and incentivize employee referrals to grow a strong team. If your top staff member recommends a candidate, it’s likely they’ll have a similar work ethic.

7. Provide a Positive Working Environment

Your staff is made of humans, and humans need to feel happy and motivated if you expect high performance. Part of this involves getting to know them on a personal, but professional, level. Find out their career aspirations, what they struggle with, and how you can help. Pay them appropriately, and offer perks and benefits—especially free or deeply discounted products. Remember, you want them to be both honest and an ambassador for your store on and off the clock.

Bottom Line

Inventory shrinkage is part of retail life, but there are many ways you can minimize it. Retail shrink fits into three categories: clerical and stock management errors, internal (employee) theft and external (customer) theft. Theft-related shrink is by far the most common problem but clerical errors and stock mismanagement accounts for a fair portion too.

Addressing and improving stock control and staff training is step one in combating retail shrink. A POS system like Square, with robust inventory tools and staff controls like unique user logins and permissions, helps retailers control stock data and track staff moves within the system.

With a POS system and sound stock control procedures in place, the next step is curtailing theft and conducting cycle counts to quickly spot shrink. Installing security video cameras and mirrors are one solution, but a visible sign threatening prosecution and staff awareness training can do the trick, too.

Want to learn more about how POS systems can help your business?

How to Use a POS System to Run Your Business
10 Benefits of Using a POS System
8 Ways POS Systems Improve the Customer Shopping Experience