What Is Inventory Shrinkage?

The definition of inventory shrinkage, in business terms, is the loss of products a business experiences over time due to factors like theft, damage, spoilage, or record-keeping errors.

The answer to the question "What is inventory shrinkage?" boils down to the difference between the amount of inventory a company should have (based on their records) and the actual quantity of items present (based on audits). Inventory shrinkage percentage is a quantifiable measure of that discrepancy.

How to Calculate Inventory Shrinkage

To calculate average inventory shrinkage at your business, use this inventory shrinkage formula:

Inventory Shrinkage Percentage = (Total Shrinkage Value / Average Inventory Value) × 100

• Total Shrinkage Value is the total value of the inventory that has been lost during the specified period of time (usually a month, quarter, or year).
• Average Inventory Value is the average value of your business’s inventory during the specified period of time. This value is calculated by adding your inventory values at the beginning and end of the time period and dividing the sum by two.

By dividing your Total Shrinkage Value by your Average Inventory Value and multiplying the result by 100, you will arrive at your Inventory Shrinkage Percentage.

What Is a Good Inventory Shrinkage Percentage?

Obviously, it’s in a business’s best interests to maintain as low an inventory shrinkage percentage as possible. However, the maximum acceptable inventory shrinkage percentage varies considerably by industry. Some industries can naturally expect higher levels of inventory shrinkage, while others should aim for as close to zero as possible.

Comparing your business’s current shrinkage percentage against benchmarks in your industry, as well as against your business’s own historical shrinkage data, will help you gauge your position accurately. 1% - 2% of a company’s total inventory value is a common shrinkage benchmark for many industries.

How to Record Inventory Shrinkage

Inventory shrinkage is typically discovered during an inventory audit at the end of an accounting period. It's important to thoroughly document the reasons behind the shrinkage, whether it’s theft, damage, or a combination of other factors.

How Is Inventory Shrinkage Reported In the Financial Statements?

Here’s how to report shrinkage in your business’s financial statements, as well as how to create the necessary journal entry for inventory shrinkage.

You’ll report inventory shrinkage on your accounting books as an expense. This entry reflects the reduction in the value of your products due to losses. Each loss may be categorized differently depending on the nature of the shrinkage. For example, if the loss is due to theft, it could be recorded under "Inventory Loss - Theft Expense."

You’ll then need to create a journal entry to record the shrinkage. The journal entry should reflect the decrease in your product’s value (debit) as well as the increase in your expense account (credit). It's also good practice to include notes with each journal entry to explain the reason for the shrinkage and provide clarity for anyone reviewing the financial statements.

Maintaining a record of product loss is an ongoing process. Regularly monitoring and analyzing your business’s financial records can help you identify trends and implement strategies to reduce shrinkage over time.

Causes of Inventory Shrinkage

The reasons for inventory shrinkage by industry vary quite a bit. For example, the retail industry typically faces comparatively high levels of shoplifting, whereas grocery stores that sell perishable goods are more likely to experience spoilage-related shrinkage.

But what factors contribute to inventory shrinkage most often? Here are some of the most common reasons for inventory shrinkage in general:

1. Theft and Shoplifting

External theft (customer shoplifting) and internal theft (employee theft) are two of the biggest contributors to shrinkage. Inventory shrinkage statistics consistently highlight theft in general as one of the most significant causes of shrinkage across almost all industries.

2. Administrative Errors

Record-keeping errors also frequently result in discrepancies. Simple mistakes like inaccurate pricing or mislabeled items are surprisingly common contributors to inventory shrinkage in many industries.

3. Damages and Spoilage

Businesses that deal with perishable or breakable goods (like food or electronics) are especially vulnerable to shrinkage due to damage or spoilage. Environmental factors, employee mishandling, and improper storage policies can all add to this issue.

4. Inaccurate Receiving and Shipping

Mistakes during the receiving and shipping process can also lead to discrepancies in inventory levels and contribute to shrinkage. For example, some items might be received but not recorded, or some items may be accidentally shipped to the wrong location.

5. Supplier Errors

Sometimes, supplier errors (like delivering damaged products or incorrect quantities) can cause shrinkage if issues aren't promptly identified and addressed.

6. Promotional Shrinkage

Promotions or clearance sales can also result in reduced inventory value when businesses sell items for lower prices than their original cost. This type of shrinkage is most common in retail.

How to Prevent Inventory Shrinkage

Wondering how to reduce inventory shrinkage? Here are some of the best ways to lower your business’s inventory shrinkage percentage:

1. Inventory Counting Software

Inventory counting software helps businesses minimize losses due to mismanaged inventory. Using inventory counting software, you can quickly and conveniently check your products as often as you need to — no more scheduling tedious annual or quarterly audits. Just use our solution to turn your own mobile device into a portable inventory counter.

Here are some of the most exciting benefits of using Zupan to improve your inventory management:

• Count your inventory ten times faster than before
• Reduce shrinkage and cut costs dramatically
• Gain better visibility into your audit trails

2. Responsible Hiring and Employee Training

Your employees play a crucial role in preventing inventory shrinkage. Make sure you’re following responsible hiring practices like checking backgrounds and references to minimize the risk of hiring dishonest individuals.

It’s also very important to provide your employees with comprehensive management and loss prevention training. Educating your employees on how to properly handle inventory and spot signs of theft is one of the best ways to reduce shrinkage.

3. Surveillance and Security

Enhancing your business’s surveillance and security measures can also help to reduce inventory shrinkage by protecting against theft. Install visible security cameras in key areas, particularly near high-value or high-risk products — not only to deter would-be shoplifters but also to ensure you have evidence in case of an incident.

Depending on the value of your products, you may even consider hiring security personnel to monitor and protect inventory. You can also implement electronic access control systems that require employees to use a keycard or a PIN to enter storage areas.

Integrated Inventory Software Simplified

While theft, spoilage, and other incidents are frequent causes of inventory shrinkage in many industries, one of the very best things you can do to reduce your losses is to improve inventory management, possibly by understanding concepts like inventory turnover ratio or exploring how AI is changing the retail industry.

We want to hear from you — get in touch today to learn more about how your business could benefit from our software!