Inventory shrinkage is a term that refers to having a certain amount of inventory showing in your accounting records, but that same inventory no longer exists in reality. As an example, warehouse computer records might show 250 exercise bikes in stock, but a physical count reveals there are only 242 on the floor.
Naturally, having fewer items in stock than in the inventory list can cause a host of different problems. This is an issue in many industries including retail, manufacturing, and wholesale operations.
Here is a list of what you can expect in this article to assist you in solving your inventory shrinkage problems:
- Common Causes Of Inventory Shrinkage
- How Inventory Shrinkage Affects Your Business
- Calculating Your Inventory Shrinkage Rate
- Ways to Prevent Inventory Shrinkage
Common Causes of Inventory Shrinkage
Inventory shrinkage happens for a variety of reasons. It’s important for any organization to take the steps required and use a proven inventory shrinkage formula to determine the breadth of the problem and discover the causes.
In the retail space, some of the most common causes of inventory shrinkage include employee theft, shoplifting, supplier fraud and general paperwork errors. In the figure above, results from the National Retail Survey 2017 showed that external factors such as shoplifting were the primary culprit, with it taking up 36.5% of the total inventory shrinkage cost suffered by businesses. The next biggest culprit was internal factors such as employee theft and subsequently followed by administrative and paperwork errors.
In manufacturing, inventory shrinkage can be caused by damage to, or loss of, raw materials during the production process. Other times certain materials may become obsolete before they can be used in time. Human error during different stages of the production and shipping processes often result in inventory shrinkage in manufacturing plants and warehouses. In some cases, issues such as using incorrect units of measure or even a natural process like evaporation can cause shrinkage.
How Can It Affect Your Business?
As you might imagine, inventory shrinkage can have a damaging effect on a company’s bottom line. In fact, the cost of inventory shrinkage has been rising over the years. In an industry survey conducted in 2017, it found that inventory shrinkage resulted in a loss of $48.9 billion for businesses in the United States. This was an increase from the previous year loss of $45.2 billion.
While manufacturing and wholesale businesses don’t need to worry about shoplifting by customers, the financial effects are still devastating. Not having materials available on hand when it shows they are available on a computer list means production may be slowed or even stopped until the problem is rectified. This production delay will affect relationships with customers, future orders, employee wages and possibly your reputation. In a wholesale warehouse, not having the required inventory means customers will have to wait and efficiency suffers.
Calculating Your Inventory Shrinkage Rate
Using the inventory shrinkage formula, you can find out your inventory shrinkage rate. Here are the steps you would need to take:
- Find out the book value of your inventory. This is the value of your inventory according to your balance sheet. Typically, this would be calculated at the end of each month, or perhaps each quarter, and is the difference between your previous inventory totals and the quantity of your goods sold. For example, if you previously had $30,000 in inventory, but you bought $2,000 and sold $10,000 of inventory, then your balance sheet should indicate that your inventory is worth $22,000.
- Then, calculate the actual value of your inventory. Do a physical check of your inventory in stock and log the quantities on the shelf and calculate the value by multiplying the inventory quantities by the purchase costs.
Using these two values, you can calculate your inventory shrinkage rate with the formula below.
You will probably have a different number compared to your book value due to reasons mentioned above, such as administrative errors or employee theft. At this point, it’s helpful to know that the average shrink rate for US businesses is 1.44%. So, if you find that your shrink rate is disproportionally higher than that, you should be concerned. But don’t worry, we have some advice and tips to help you reduce your inventory shrinkage.
The Need For Effective Inventory Shrinkage Prevention
The key to preventing inventory shrinkage is to acknowledge it is happening and take quick action to put an end to it. Understanding the causes of inventory shrinkage is the first step towards reducing it.
Below we outline 8 ways to prevent inventory shrinkage, divided into the top 3 categories that account for 88% of all inventory shrinkage cases.
Addressing External Factors (37% of inventory shrinkage is caused by external factors)
1. Invest In Surveillance
Invest in security cameras and place them around your stock locations. In addition, put up warning signs of theft around your stock. By monitoring your inventory carefully, you can spot any suspicious behavior and take action when necessary. Cameras and warning signs serve as a deterrence for thieves who do not want to risk the chance of getting caught.
2. Implement Security Measures
Fence off or secure your inventory locations or warehouses using other means to prevent unwanted entries. Also, implementing a strict security protocol to control access to the warehouse will help prevent unwanted entry.
Warehouse burglaries are known to be the highest value incidents due to the large volume of goods in one particular location. Therefore, it pays off to invest more in warehouse security to prevent your company from suffering a massive loss from robberies.
3. Prevent Fake Promotion Codes
Giving promotions is an excellent way to drive up sales of your products. However, scammers often take advantage of these promotions. With an increased supply of online discount stores, many scammers circulate fake manufacturer coupons online. When this happens, a manufacturer can determine these discounts to be invalid and revoke them. Your business could be forced to absorb the loss of these reimbursements, which would likely have a devastating effect on your margins.
Always ensure that your employees are kept up to date with the online promotions your store is running and the latest coupon scams. You will also need to educate your employees on how to detect promotional coupon frauds, such as unusually high discounts or a higher-than-average number of coupon redemptions. These are just a few of the signals that something dubious might be happening and someone may be taking advantage of your promotional activities.
4. Reduce Temptation
To prevent on-premise theft in retail stores, higher-value items should be stored in secure areas that require a store employee’s authorization to access them. For example, some wine and spirit stores stock their pricier alcohol at the cashier area. For a customer to purchase or look at them, they must ask a store employee to assist them. This makes it harder for shoplifters to target your more lucrative items to steal.
Combatting Internal Factors (30% of inventory shrinkage)
5. Eliminate Fabricated Sales Transactions
Sales fraud can take on many forms: from giving excess discounts and pocketing the difference to falsifying vendor bills. Here are some common examples of how this happens:
- An employee deliberately inflates the quantity of the goods sold with an intention to steal the excess inventory.
- Creating fake customer accounts where products are sold to an undisclosed location for the employee to sell on their own while the bills are set to due for collection but are never collected.
- The setting up of fake vendor accounts to pay for bills or products that will never reach your warehouse while the employee pockets the money.
- Creating a vendor kickback scheme where your company overpays a vendor for inventory goods, only to have the insider in your company get a cut of the overpayment as an incentive for continuing the scam.
There are several ways to combat this issue. First, split up responsibilities for important tasks in your business workflow. That way, any key process must pass through a few individuals. For example, assign one individual the responsibility to approve the sale and another to fulfill the order from inventory. This will lower the chance of any fraud from occurring with the process becoming more transparent for the entire organization.
Secondly, you can set internal controls in place where only a select group of people can create or view certain transactions. With restricted access, you can be assured that employees are not given the freedom and access to manipulate and cheat your system.
Thirdly, ensure that you conduct spontaneous and regular audits to inspect your internal business operations. Look into any suspiciously close relationship between your team and your vendors or customers. Follow up on any dead accounts or uncompleted transactions to verify if the order and customer are legitimate.
6. Stop Shipping Fraud Activities
Fulfillment can often be a difficult place to detect scams, due to the hectic activity of a warehouse shipping and receiving items. To avoid fraud, check your shipping slips and shipments carefully for products that claimed to be “defective.” For these goods, ensure that you have an inspection process in place to verify those claims before disposing of them. Assign your inspections to someone not on the shipping team to prevent a conflict of interest. Also, it is good to keep a record of these inspection reports to analyze any strange pattern or trends that are worth digging further.
7. Implement An Inventory Tracking System
Having an inventory tracking system allows you to be aware of all your inventory at all times. From your raw materials to the final sales process, it is vital for you to know where your inventory is at all times. By keeping track where each stock is, you can examine if your goods are genuinely missing or due to some other reasons. You can track your stock on an individual or a lot tracking level, depending on your business requirements.
Eliminating Administrative And Paperwork Error (21% of inventory shrinkage)
8. Invest in an inventory management software
Using software to automate and manage your inventory can help to eliminate administration errors. Firstly, you will have an organized workflow which you can easily monitor and maintain your inventory movements accurately. By restricting employees access to specific functions only, you can prevent fraudulent activities by having control of your whole operations.
Secondly, managing your inventory with a centralized system is easier compared to rotating between all your different accounting, shipping, and manual spreadsheets. Doing so will reduce the chances of duplicate and wrong errors dramatically.
At Sweet Technology, we provide an inventory and order management software that can help solve your inventory shrinkage issues. With Sweet, you know that your business will always have an accurate and real-time view of your entire inventory operations.
Get in touch with us today for a free 14-day trial to get the process started.