Inventory Shrinkage Guide for Small Businesses (+ Calculator)

Inventory shrinkage is the difference between a product’s recorded stock count and the amount physically on hand. The difference between these two amounts is referred to as “shrink.” In a retail setting, it is also sometimes called retail shrink. Either way, both mean the same thing—you’re missing inventory you thought you had.

In general, there are three causes of inventory shrink: shoplifting, employee theft, or inventory control issues like receiving errors, unrecorded damages, cashier mistakes, and misplaced items. Some level of shrink is an unavoidable part of retail. It is important, however, that you prevent shrinkage whenever possible to avoid losing money and time.

Use our free calculator to calculate your shrinkage:

How To Calculate Inventory Shrinkage

Retail shrink can be measured in two ways. You can calculate shrinkage in terms of the number of physical units lost or as a percentage.

Calculating Retail Shrink as Units

To calculate your retail shrinkage, you need to take two factors into account: your recorded inventory and your actual count. From there, the formula looks like this.

Inventory shrinkage = Recorded inventory – Actual inventory

Here, your recorded inventory can either come from an integrated point-of-sale (POS) system like Lightspeed that will track and run reports automatically on your inventory or from a manual tracking method. Then, your actual inventory is the number of units you count physically in your store. When you subtract those two values, the value you get will be your inventory shrinkage and represents the actual amount of inventory you lost, expressed in units.

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Let’s take an example: Say you run a gift shop and you’re performing a stock count at the end of a busy week of sales and reorders. According to your POS system, you should have 500 units of ornaments on-hand. However, after performing your count, there are actually only 477 ornaments. In this case:

Inventory shrinkage = Recorded inventory – Actual inventory

Inventory shrinkage = 500 – 477

Inventory shrinkage = 23 units of ornaments

Calculating Retail Shrink as Percentages

In addition to calculating shrink in terms of units lost, you can also track your inventory shrink with the inventory shrinkage rate. Your inventory shrinkage rate measures the percentage of goods lost between what you recorded and what actually sold. The equation for your inventory shrinkage rate is as follows (and expressed as a percentage):

Taking the same example as before. If you wanted to find the rate of inventory shrinkage for the gift shop’s ornaments, you simply input the units into the inventory shrink rate formula and calculate:

In this case, the inventory shrinkage rate is 4.6%, meaning that something is happening where 4.6% of your gift shop’s ornament inventory is going missing. If nothing is done, then you can expect to continue to lose 4.6% of your ornaments to shrinkage.

Causes of Inventory Shrinkage & Prevention Strategies

As we mentioned previously, you can generally attribute shrinkage to three causes: shoplifting, employee theft, or clerical errors. Here, we will look at the typical causes for inventory shrink in detail as well as strategies for preventing them:

Shoplifting

Shoplifting and other forms of nonemployee theft account for a significant amount of retail inventory shrinkage.
(Source: BigStock)

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 where these thefts occur.

Businesses that sell high-value, high-demand products are also often targeted by shoplifters. For example, when I managed retail spas, aestheticians locked away their 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.

Tag swapping is another pervasive form of retail shrink that affects inventory numbers and profits directly. Tag swappers place a lower-priced item’s tag on a higher-priced product and then complete the purchase. This strategy 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.

Minimize tag swapping by using descriptive barcode labels and training employees to check that the product and price that scans during checkout matches the product in-hand.

Other types of customer theft, such as coupon scams or online fraud, also affect your profits and bottom line but aren’t necessarily revealed as missing units. You can spot this type of loss by examining sales figures and discount reports—this is where using a robust POS system comes in handy.

Shoplifting Prevention

As mentioned earlier, theft can affect your bottom line drastically; with more than 400 million incidents of shoplifting per year, it’s a serious issue that you need to arm your business against. Here are some of the ways you can prepare your business for shoplifters and deter them from taking your goods.

• Optimize your store layout: When planning your retail store layout, position your checkout near your store’s entry, so that you and your staff can see every person that comes and goes. If that’s not possible, at least make sure that there is a clear line of sight from your cash wrap to the exit.
• Use mirrors, signs, and cameras: Don’t be afraid to let customers know you’re watching them. Honest customers won’t care, and the precaution will make thieves wary. Security mirrors and video cameras can be placed strategically so that you can watch over areas that are hard to see from the checkout and other staffed areas. Add a few signs letting people know that they are being watched.
• Secure expensive goods: Take extra steps to protect your expensive goods with secure cases or by placing them close to watchful eyes. Your register or other areas where staff members are always present are great places to merchandise your most valuable items
• Install a security system: According to the National Retail Federation (NRF), 52.8% of retailers are planning to allocate more resources to theft prevention technology, which makes sense. Security systems allow you to keep watch over your store, sound alarms, and get alerts if something were to happen. We recommend SimpliSafe, which is an affordable option with 24/7 monitoring, customizable program options, app-based controls, and a proven ability to effectively save businesses money.
• Educate and train staff: Train your staff to look out for any suspicious behavior and report it without hesitation. They should pay attention to what merchandise goes in and comes out of dressing rooms. During checkout, you can also train your clerks to spot-check that purchased bags are empty and that tags correctly match the items. Note, however, that you should never encourage staff to do anything that might jeopardize their safety.

Employee Theft

Although employee or internal theft is the exception and not the norm, the cost of only one dishonest employee on average is $1,551.66. Unfortunately, internal theft can be tough 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. Later, we will look at some of the ways you can deter employee theft, from making a pleasant work environment to installing access controls.

Employee Theft Prevention

Employee theft is a frustrating topic and often uncomfortable to broach. However, every retail store owner eventually comes across a less-than-honest employee. And even otherwise loyal staff sometimes push the limits by stacking discounts or giving employee discounts to friends.

Here are some ways to protect your business from less-than-upstanding staff:

• Screen your candidates: The best way to prevent employee theft is to hire honest staff in the first place. Increased employee screening has been adopted by more than a quarter of retailers to help fight inventory shrinkage from internal theft. Run background checks, such as those done by GoodHire, follow up with references, and incentivize employee referrals to grow a strong team.
• Require employee logins: A POS system that supports unique staff logins gives business owners a powerful tool to prevent employee theft-related inventory shrinkage. It allows you to see detailed reports on which staff members handle receipts, sales, inventory adjustment, returns, and applied coupons to sales. You can also use staff logins to limit staff access to only the systems and areas they need to get their job done.
• Conduct regular audits: Audits comparing sales and inventory reports with physical stock are great for detecting shrinkage. Doing so regularly will make it easier to track down the source of any discrepancies. Audits deter employees from engaging in theft and make stealing much more difficult to get away with. They are also essential for being sure that your accounting is accurate, and there are no discrepancies between your records and your actual inventory. An inaccurate picture of your stock can lead to bad inventory decisions and inaccurate reporting.
• Place cameras in employee-only areas: In addition to using cameras on the sales floor to deter shoplifting, don’t hesitate to use video cameras in your store’s backroom and 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 of their employee privileges.
• Use checks and balances: Stock counts and receiving tasks are opportunities for dishonest staff to hide theft within inventory adjustments and stock receipts. Having a two-person system for stock check and receiving creates more accountability and makes it harder for dishonest employees to steal.
• Create a positive work environment: If your employees respect you and your business, they will be less likely to try and take advantage. Pay your staff appropriately, offer perks and benefits, and treat them with compassion. Remember, you want your employees to be honest and ambassadors of your business both on and off the clock.

Clerical Errors

Avoiding stock control errors will improve your grasp of your inventory and help you avoid false shrinkage.
(Source: Multichannel Merchant)

Stock control and clerical errors are other common causes of retail shrink. Some errors might be as simple as miscounts and do not reflect physical losses. Others can be costly, such as recording all of the goods in a supplier shipment as “received in full” when some items were actually missing from the shipment.

Clerical errors can also create a false sense of inventory shrinkage because they result in an inaccurate picture of your actual inventory counts. For example, if you thought that you had 120 units of a shirt and recorded it as such, but then you really only had 100 units and lost none, you would believe falsely that your shrinkage rate was near 17%.

We will go into more detail below, but the best way to mitigate recording errors is to automate your inventory management with a POS system wherever possible.

Clerical Error Prevention

Accurate stock counts are essential for spotting theft-related shrinkage quickly. Clerical errors, however, happen all the time, despite being the easiest inventory shrinkage issue to solve. It is typically a matter of fixing your receiving, counting, and tracking procedures as well as automating your processes.

Here are some steps you can take to mitigate clerical errors:

• Create a strong inventory management system: Establishing a solid inventory management system is the first step for preventing inventory shrinkage due to clerical and stock control errors. Inventory management procedures will help you order, count, and receive your merchandise accurately so that you know exactly what quantities you have. After the initial count, you can continue to manage your inventory manually, although we recommend an integrated POS system like Lightspeed to track your merchandise and run reports on your sales.
• 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. As a general rule of thumb, be sure you are doing cycle counts for each product at least once a quarter. You will want to keep a closer eye on your more expensive inventory through more frequent cycle counts. A $300 television would be a bigger loss than a $1.99 soft drink, after all.
• Use barcode labels: Another way that you can prevent clerical errors is by tagging your merchandise with scannable barcode labels and stock keeping unit (SKU) numbers. This will reduce associate entry errors and speed up your checkout process. Additionally, if you use an integrated POS like Lightspeed, scannable barcodes and SKU numbers will keep your sales and inventory counts accurate.
• Adopt FIFO inventory management: First-in, first-out (FIFO) inventory management assumes that your oldest items get sold first. It is used widely by businesses that sell products that spoil or have expiration dates like food, personal care, and cosmetics. FIFO typically includes shelving older items in front of newer items and running promotions on old products. Because you look a bit closer when shelving, it helps to catch misplaced items and keep your stock under control.
• Receive and record stock quickly and accurately: Receiving stock shipments promptly and correctly helps prevent all sorts of inventory shrinkage headaches. To do this, receive and unpack all boxes in the same space, count each box, and check the items received against original purchase orders. You should only record your inventory numbers after vetting them closely as sloppy receipts lead to inaccurate numbers, missing inventory, and payments to suppliers for stock not received.
• Remove damaged items from stock count: Damaged goods are inevitable in retail, whether damaged in transit or in-store by shoppers. When you discover damage, adjust your stock count quickly and dispose of the item. If you don’t, your counts will be off, and the missing unit will look like a shrinkage issue. Make this a store policy and educate your staff on how to dispose of and record damaged goods.
• Automate where possible: If you can automate your processes with software solutions, do so. This will not only make your inventory counts more accurate, but will make all of your inventory processes faster, allow you to pull retail analytics reports, improve your budgeting, give you insights into your revenue stream, and make it easy to learn more about your customer base. The solutions are endless, and you should utilize them wherever you can.

Bottom Line

Inventory shrinkage can be a huge detriment to your business and lead to huge losses. In 2020, more than 15% of United States retailers said that they experienced an inventory shrink of 3% and higher. Either due to theft or clerical errors, inventory shrinkage is a part of retail, but that doesn’t mean you shouldn’t try to prevent it. Here, we looked at how you can calculate your inventory shrinkage, the issues that typically cause shrinkage, and ways that you can mitigate shrinkage in the future.

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