Inventory shrinkage, or “shrink” is a retail industry term used to define losses. It’s commonly referred to in terms of a percentage of a company or a location’s total sales. According to the Sensormatic Global Shrink Index, shrink represents $100 billion in annual loss for retailers around the globe. From preparing for inventory audits to calculating your shrink percentage, here is everything you need to know about inventory shrinkage.
How to Calculate Inventory Loss
Throughout the year (or a given time period), merchandise is shipped to a location. During that time period, merchandise is sold, transferred to other locations, or returned by customers. Your “book inventory” is a running count of these exchanges, so you know how much merchandise should be in a location. When taking inventory, all items in a location are counted―usually by electronically scanning merchandise price tickets―to determine the actual physical inventory of the location.
You can either calculate inventory shrinkage by the retail (selling price) value of merchandise to the retail sales value or by the cost (company purchase price) of merchandise to cost of sales. Most calculate the retail value, but either will work as long as it’s used consistently across locations.
Here is the formula used to calculate inventory loss:
Book inventory – actual physical inventory = total loss
Value ($) of loss / total sales during period = shrink %
Here is an example of calculating shrink:
Your location was sent $100,000 worth of merchandise over the last 12 months. Of that $100,000, $25,000 was sold to customers, $2,000 was damaged and returned, $4,000 was transferred to another location, and $1,000 was returned after purchase by a customer.
$100,000 – $25,000 – $2,000 – $4,000 + $1,000 = $70,000
This means your book inventory is $70,000. However, during the physical inventory count, you find that your location only has $60,000 in merchandise.
$70,000 – $60,000 = $10,000
This means that your location’s total loss is $10,000.
During this time, your location had $200,000 total sales during the period.
$10,000 / $200,000 = 5%
Your shrink percentage for your location is 5%.
Whether a 5% shrink percentage seems high or low is subjective. However, as an average, most retailers want this shrink percent to be under 1% of sales. According to the previously mentioned Global Shrink Index, the average shrink percentage for a retailer is about 2%.
Causes of Inventory Shrinkage
When you track every piece of merchandise within your company, it can be perplexing to understand how shrink happens. There are three potential causes of loss in the retail environment:
- External theft: customer shoplifting or vendor theft. According to the National Retail Federation, this is the leading cause of inventory shrinkage in retail, accounting for about 36 percent of annual losses in the U.S. alone.
- Internal theft: employee dishonesty. This is the second biggest source of inventory shrinkage. Employee theft can be attributed to about 30 percent of all shrinkage.
- Administrative error: mistakes in processes like transfers, file prices, inventory shipments that go undetected. This accounts for about 21 percent of inventory loss.
How to Identify High-Shrink Stores
Why do some locations have a higher shrink percentage than others? Stores with the worst loss tend to have these three qualities:
- High turnover. According to the National Retail Security Survey (NRSS), retailers with a high turnover rate for store managers experience significantly higher shrinkage rates. It’s important to compare a location’s turnover to the company average.
- Low compliance. From brand image to merchandising and employee behaviors, a compliance audit can help identify dishonesty. The number of employee relations issues can be a tell-tale sign of a high-shrink store.
- Little or no theft activity reporting. While this seems paradoxical, locations that don’t report any incidents throughout the year usually aren’t attending to the issues. Be sure to review a location’s reporting history of theft and loss issues.
Additionally, you’ll also want to review refunds, voids, cash shortages, and damages when identifying and analyzing your high loss locations.
What About an Inventory Overage?
The opposite of loss, an overage occurs when your physical inventory is greater than your book inventory indicates. Companies should worry about overages because it means there is no clear line of sight to the actual losses and that some error likely occurred in your inventory process, like merchandise being counted twice. Often, inventory overages tend to self-correct in subsequent inventories.
Ensure Accurate Inventory Results
Accurate inventory results are built from comprehensive processes and policies that are enforced at every location and warehouse. HS Brands’ loss prevention services are designed to take an objective approach to combating inventory loss for retailers across the globe. We’ll work with you to build a complete loss prevention program—from audits to program and policy development—to meet your goals and protect your brand.
In addition to loss prevention, HS Brands offers mystery shopping and royalty assurance services to provide holistic assessment and verification of your expectations.
Contact HS Brands today to see how we can prevent and reduce inventory shrinkage in your organization.
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Raymond Esposito
Director of Business Development & Marketing
HS Brands Global
Raymond Esposito has over 28 years of loss prevention experience, working within the department store, specialty, and grocery segments of retail. He has developed loss prevention programs for over 125 retailers in the U.S., Canada, and the United Kingdom. He holds a bachelor’s degree in psychology from the University of Connecticut and is an expert witness.
