Shrinkage in Business: Definition, Causes, and Impact

AutomationInventory management software lowers the probability of incorrect data entry and other critical mistakes as products transfer from the stock room to the sales floor. Conduct inventory loss analysis at a forensic level with increased transparency in movement histories and stock counts. Plus, ensure you always have the right amount of stock without spoilage from over-ordering. Unique identifiers for productsAssign SKUs, QR codes, or barcodes to each of your items to promote accurate recording and tracking of your inventory.

Conduct an inventory audit and amend your records accordingly. In businesses with complex supply chains, the inventory may at one point be handled by third parties who are not part of the company. The theft may occur during transit from the supplier’s warehouse to the business premises or when loading and unloading the products. Deliveries should be counted every time they enter or leave the business premises and recorded appropriately. Learning how to set par levels and us the reorder point formula is how to stop shrinkage by lessening waste and spoilage. A par level is the amount of inventory you need to have available between receiving shipments to make sure you’re meeting customer demand.

An organization should track the inventory shrinkage percentage over time to gauge whether there is an increase or a decrease in shrinkage. The inventory count should be compared to the previous inventory counts. When a business discovers a shrinkage in its inventory, any discrepancies should be accounted for to reconcile the records with the physical inventory count. The matching principle requires that inventory shrinkage should be recorded as an expense in the financial period in which it occurred to match it against the revenues for that year. A shrinkage expense account will be recorded under the Cost of Goods Sold (COGS) account.

Shrinkage Sources by Industry

This type of shrinkage is especially hard to solve because any plan of attack is based on faulty information. Thankfully automation has gotten us pretty far in dealing with both of these problems and we’ll touch on that in a bit. Accurately calculating inventory KPI like average inventory, inventory days, and inventory carrying cost can all be automated. And finally, a medium-sized wine bar receives their shipment of 6 cases from the wholesaler. They put the wine in their cellar, open the first case, and begin selling it to guests. At some point the wine bar takes beverage inventory and finds they’ve sold 40 bottles and have 31 left.

However, inventory is often lost due to any number of reasons, causing a discrepancy between the book inventory and the physical inventory. The difference between these two inventory types is shrinkage. Having multiple after-tax income employees double-checking inventory prevents both fraud and mistakes, so it’s one of the most effective ways to limit inventory shrinkage. Yes, record inventory losses as an expense in your financial books.

1. The Ascent is a Motley Fool service that rates and reviews essential products for your everyday money matters.
2. Shrinkage is the difference between recorded inventory on a company’s balance sheet and its actual inventory.
3. Vendor fraud is alternatively known as supplier fraud or wholesaler fraud.
4. Anti-theft sensors or ink security tags attached to products lower the chances of an opportunistic grab-and-dash.
5. Employees may take some of the business stock to compensate for an amount they feel they are being underpaid, underappreciated, or undervalued.
6. Finally, pay employees fairly and strive for good morale in your retail environment to promote solidarity and trust between the company and your team.

It’s as simple as the person or entity who is selling you products not delivering the promised amount. The wine bar that orders 6 cases of wine has no problem verifying that 6 cases have been delivered. If the wine-bar https://www.bookkeeping-reviews.com/manage-operations/ in our example input 10 bottles of wine per case instead of 12, they would have recorded 60 bottles in their inventory instead of 72. Right there, that’s 12 bottles of wine that won’t be accounted for.

Administrative and Paperwork Errors

Hired employees should undergo rigorous training on how to handle inventory appropriately and carry out stock-taking. Imagine a small, 5-acre vineyard that produced 600 cases of wine this harvest. They have a contract with a wine wholesaler who buys every case available to distribute to retail wine shops, bars, and restaurants. But the vineyard only has 598 cases of wine to sell to the wholesaler. The process of bottling, labeling, packing, storing, and shipping the wine cause 2 cases—24 bottles—to disappear.

But it’s harder for the wholesaler to count the 598 cases of wine they got from the vineyard. If it’s unrealistic to count, it’s unrealistic to verify that you got the right amount. From a retail shrinkage perspective, think ringing up the wrong item.

As you can tell from the word choice, inventory shrinkage can’t be eradicated. One of the best ways to cut down on human entry error is to remove the human entry part. With a fully connected inventory management and point of sale system, you can worry less about mismatched numbers. However, there are things you can do to get your shrinkage rate as low as possible. Let’s say you have $200,000 worth of inventory according to your records. You do an inventory count and find you actually have $197,000 on hand.

What is Inventory Shrinkage?

Anti-theft sensors or ink security tags attached to products lower the chances of an opportunistic grab-and-dash. Vendor fraud preventionFrequently audit your wholesalers by reviewing your master files and comparing your suppliers’ invoices against purchase orders and goods receipts. Assign multiple employees to vet vendor invoices to prevent a worker from duplicating invoices or soliciting payment from fake vendor accounts.

Even as stores increase security through the use of CCTV cameras, digital tags, and other means, some customers still manage to steal inventory. Divide the difference by the amount of stock recorded in the accounting books to get the percentage of inventory shrinkage. Inventory shrinkage is recorded when you want to reconcile your sitting inventory with your inventory records. If you find less on your shelves than your eCommerce accounting reflects you’ve sold, you’ve got shrinkage. Before you determine inventory shrinkage, it’s crucial for you to understand the average inventory formula. Shrinkage is caused from the loss of inventory due to shoplifting, administrative error, employee theft, vendor fraud, and broken items, among other reasons.

Every time an item is sold, the inventory account is reduced by the cost of the product, and revenue is recorded for the amount of the sale. Discrepancies between what’s on your factory floor and what’s in your accounting records are a frustrating problem, but a totally solvable one with a few adjustments. However, it may require a complete overhaul of your current inventory management processes. You’ll need to diagnose the problem before you solve it, so it’s important to approach the problem with care and deliberation.