What is Inventory Shrinkage and 7 Ways to Reduce It

What is Inventory Shrinkage and 7 Ways to Reduce It

Table of Contents
Table of Contents

Running an inventory centric business is a hefty job.  Managing inventory shrinkage is important to reduce inventory costs and improve margins.

What is an Inventory?

Inventory is the goods that a business source or produces with a vision to sell in the market. To obtain these goods, a business has to invest a sum of money.

Several businesses invest in goods with the purpose to sell and make a profit. These businesses are titled inventory stocked businesses.

Inventory shrinkage is a loss which many inventory-centric businesses face. But what is this loss exactly? Let’s understand that better.

What is Inventory Shrinkage?

Inventory shrinkage implies the difference between the value of inventory available and of inventory bought.

In most cases, the amount of inventory available falls short of the amount of inventory brought. This causes a huge loss to the business. T

he world market losses billions of dollars in inventory shrinkage each year. This affects the profitability count of the business.

Inventory shrinkage also pushes the cost of each product on the higher side for the seller. While it is inevitable for an inventory-based business, yet, there are ways to reduce the shrinkage.

How to Calculate Inventory Shrinkage?

Calculating Inventory shrinkage requires physical labor. Conduct a physical count of each item present in the inventory in the outlet/warehouse.

Now subtract total inventory in the stock from inventory mentioned in the books.

You may choose to calculate it by value or by count.

Formula to Calculate Inventory Shrinkage

Inventory in Books (Number or Value) – Inventory in Physical Stock (Number or Value) = Inventory Shrinkage

In a similar pattern, one can also calculate the Inventory Shrinkage Rate. The formula to calculate Inventory shrinkage rate is

(Inventory in Books – Inventory in Physical Stock)/Inventory Produced or Bought = Inventory Shrinkage Rate

Which Accounts are Affected by Inventory Shrinkage?

Recording losses that occurred by inventory shrinkage is mandatory. To record the losses you will have to understand the losses. Understand these losses with synchronization to their value. Analyze the size of the loss to place them in the right account in the books.

If the loss occurred is small, debit it in the cost of goods sold account (COGS). If the loss occurred is large, it will need a specific account. Create a new account that especially accommodates the losses that occurred due to shrinkage. Debit the loss in the new account. This way, you will be able to manage your gross profit excluding the mass loss.

To show the loss in the book, show an increase in shrinkage account and decrease in the inventory account.

What Should be an Ideal Inventory Shrinkage Rate?

The average inventory shrinkage rate differs depending on the industry of the business. However, experts believe an ideal inventory shrinkage rate should be between 1 and 2 percent. Although, it is wise to make sure you record as little inventory shrinkage rate as possible.

It is vital to understand the major causes of inventory shrinkage to reduce the inventory shrinkage rate. It is also vital to curate measures to rectify the causes of shrinkage.

What Causes Inventory Shrinkage?

Before jumping to the solution of the problem, let’s understand the problem thoroughly. There are several reasons that cause inventory shrinkage. Some of them are -:


Theft is the most prominent reason that causes inventory shrinkage. A large business shall be able to hold someone accountable when shrinkage occurs. A small business on the other hand often fails to hold someone accountable. The two most common kinds of thefts are –

1. Consumer Theft

This theft simply translates to shoplifting. In large physical stores, shoplifting can be a challenge. But it is not one in the small-scale stores and outlets. The products coming in tiny packages are easy to swipe inside a bag or underneath clothes. Large items are saved from the practice.

2. Employee Theft

Statistics say employee theft holds 42% of the inventory shrinkage of the company or the business. The reason is, the employees are in the closest proximity of the inventory, and can find loopholes in the security (in the warehouses/stores). Overcoming this situation may be tough but is not impossible.

Administration Error

Administration errors mean the reason for the appearance of inventory shrinkage in the books is because of administrative fault. This can be because of wrong data entry, errors in cash counting, not recording the sales right.


Damages make it impossible for a product to be sold. These damages could be during transportation, while in the storage unit, or at the store. Water damage, breakage, cracking, etc. all factors fall under the category of damage. This forces the business to incur the loss caused from the company’s inventory accounts resulting in inventory shrinkage.

Perishable Inventory

All the items are discarded because of damage, yet there are several items that are perishable. Health care items, food items, dairy, medicines, and a lot of other category goods are perishable items. Once a product is not sold till the date of expiration, it becomes a waste matter. This cannot be sold by the company and the cost is included in inventory shrinkage.

There can be a few more reasons accountable for inventory shrinkage. But the ones mentioned above are the most prominent ones to be reported. Some of them seem unavoidable. However, the scope of reducing the temperament of carelessness can turn the wheel around to reduce Inventory shrinkage. There are a lot of ways in which a business can save the cost of inventory shrinkage. Simply curate the right tricks and rules and implement some in the business.

7 Ways to Reduce Inventory Shrinkage

Inventory shrinkage is a concept in business that can be won over with the implementation of the right measures. Some businesses may yet not know they can reduce the extra loss they are suffering with.

This is why it is time for them to understand the concept. In the good news, we have ample ways to turn the inventory shrinkage around. We have described 7 solid ways in which the process can be altered to make sure the inventory is safe on its grounds.

#1 Responsible Recruitment

As per the stats, 42% of inventory shrinkage occurs because of employee theft. This can be cured with ease. Mark the responsibility of the inventory with one position. The employee recruited to the position will then should take thorough training. The employee should be assessed on moral grounds as well as on expertise. This way, the company can hold one person accountable for inventory shrinkage and rectify the situation in the long run.

#2 Security Check

Security checks should be a non-negotiable concept when it comes to inventory. The warehouse or the retail outlet should be covered with a web of CCTV cameras. The products can be pinned with tracking devices if limited in numbers. Grocery and tiny products can be kept in locked cupboards. Anti-theft alarms can be placed at the security check along with a manual checking process. This will save the company from inventory theft.

#3 SKU and Barcode Implementation

SKU and Barcode give each product a unique identity. This way, it becomes extremely easy to keep track of the liquidity of the products. It also helps in tracking which product is in more demand in comparison to others.

#4 Cross-Check Responsibilities

There is another way of ensuring the inventory is safe by giving employees cross-checking responsibility. Assign two different employees to keep a check on the inventory, prepare reports, analyze, and match them often.

#5 Consistent Inventory Audits

The employees in immediate connection with the inventory may commit fraud or mistakes, an outsider won’t. Bring a supervisor in consistent intervals to conduct inventory audits. This will ensure in-depth bookkeeping of the inventory, resulting in tight security and a decrease in employee theft.

#6 Automated Inventory Management

An automated inventory system helps the company to escape from depending on manual labor. This results in a decrease in errors. It will also speed up the process of inventory count, cash management, better insight holdings, and more. This will ultimately result in a reduction of errors and losses in the process.

#7 Periodic Inventory Level Checks

Periodic inventory checks allow a business to estimate the losses and expenses caused by the inventory.

By maintaining the records over time, the process can help in drawing a comparison of losses that occurred over time and differences after each check. In the long run, it will help in bringing the inventory shrinkage down.

Key Takeaways

And that's a wrap. Here is a quick summary of what we covered in this post.

Inventory - Inventory is the goods bought by a business with a vision to sell and make profit.

Inventory Shrinkage - It is the difference between the cost price of inventory available and of inventory bought. Inventory shrinkage is treated as a loss to the company.

Formula to Calculate Inventory Shrinkage - Conduct a physical count of inventory available. Then apply this formula

Inventory in Books (Number/Value) – Inventory in Physical Stock (Number/Value) = Inventory Shrinkage

Accounts Affected by Inventory Shrinkage - Inventory shrinkage precisely affects 2 accounts. It affects the COGS account and the inventory shrinkage account.

Ideal Inventory Shrinkage Rate - The ideal inventory shrinkage rate is between 1% and 2%.

Causes of Inventory Shrinkage


- Administrative Error

- Damages

- Perishable Inventory

Ways to Reduce Inventory Shrinkage

  • Responsible Recruitment
  • Security Checks in the facility
  • SKU and Barcode Implementation
  • Cross-Check Responsibilities
  • Consistent Inventory Audits by an External Supervisor
  • Automated Inventory Management Systems
  • Periodic Inventory Level Checks

To further improve your inventory management, be sure to check out the following articles:

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