How To Identify and Prevent Inventory Shrinkage In Your Retail Business: Part 1

Inventory shrinkage is when you lose inventory due to factors other than sales.

One of the biggest challenges that Retailers in Kenya face is inventory shrinkage. If left unchecked, inventory shrinkage will most definitely cause a business to make losses and even close shop. But what is inventory shrinkage?

Inventory shrinkage is when you lose inventory due to factors other than sales. It can generally be defined by the difference between your inventory levels on paper and your actual inventory levels. Every retailer across every industry is impacted by shrink, with organized retail crime being one of the industry’s prime concerns (but not, notably, the only cause of shrink).

What does shrinkage mean for retailers?

If your inventory management system says you have 10 shirts in stock, but you actually have 9 on hand, and you can’t account for that lost pair through sales, your inventory has experienced shrinkage.

Shrinkage hurts retailers in two key ways:

• Lost cost: when your inventory is lost to shrinkage, you’ve thrown the expenses involved in acquiring that stock out the window.
• Lost profits: inventory represents more than just its cost to acquire. All of the stock on your shelves is potential cash flow waiting to be freed up by a sale. If your inventory shrinks, you have less assets available to acquire new inventory, pay sales staff and grow your business.

If your inventory management system says you have 10 shirts in stock, but you actually have 9 on hand, and you can’t account for that lost pair through sales, your inventory has experienced shrinkage.

Types of retail shrinkage

Inventory shrinkage can be broadly classified into three categories: loss, damage and operational mistakes.

Here’s a quick description of each of these types of shrinkage:

Loss

If your inventory has shrunk due to loss, the items in question are no longer in your possession. Typically, this is because of internal and external theft. You paid for these items, and can no longer sell them.

Damage

If damage has occurred, your sellable inventory has shrunk, but the item itself may still be in your possession (depending on the extent of the damage). Damage often requires disposing of an item. It’s sometimes possible to repair damaged merchandise or sell it as-is, but you’ll lose out on revenue due to either repair costs or discounted prices.

Operational mistakes

Merchandise may have been miscounted or shipments may have been entered incorrectly. With operational mistakes, shrink is more theoretical—you never had that inventory in the first place, but your teams were operating under the assumption that you did.

According to the Kenya Retailers Federation, shoplifting (of all kinds) is the biggest source of shrink.

What factors contribute to or cause inventory shrinkage?

Inventory shrinkage doesn’t have one singular cause. The best way to combat shrinkage is to know where yours is coming from.

Here are some common causes of shrinkage.

Shoplifting

When most retailers in Kenya think of shrink, they think of theft, or shoplifting. 

But shoplifting is more than just straightforward theft. Price tag swapping also falls into this category, where a shoplifter pays less than what an item is worth because a different item’s SKU is recorded in the sale.

Organized retail crime, where two or more people conspired to steal merchandise to resell, also falls under the shoplifting label.

According to the Kenya Retailers Federation (KRF), shoplifting (of all kinds) is the biggest source of shrink.

Employee theft

Employee theft, also known as internal theft, is a significant contributor to shrinkage. The KRF’s survey found it was the source of 28.5% of inventory shrinkage, second only to shoplifting (external theft).

Theft, fraudulent returns and neglecting to scan items for friends and family lead to mismatches in your inventory levels and can add up to big losses for your business.

Human entry error

Poor inventory management in retail business in Kenya isn’t just frustrating. It can lead to shrinkage as well. Whether it’s misclassifying a product, a typo in a name, scanning a shipment twice or incorrectly entering numbers after a cycle count, if your records are off, your reorder and revenue calculations are off. When you correct those records, you might end up with shrinkage.

On its own, shrinkage due to administrative errors doesn’t necessarily mean lost cost—but it does mean lost profit, as you were likely forecasting more revenue than your actual inventory numbers can bring in.

Vendor error and theft

Vendors can be subject to the same administrative errors as retailers, which can contribute to shrinkage. Both you and your vendors can the risk of human entry error by using integrated systems

Some dishonest vendors can steal from you by not delivering a full order, though this is, by far, not the way the majority act. Vendor theft is not a very large contributor to shrinkage, and many retailers will not fall prey to it.

Damage

Accidents happen! Sometimes goods are broken without any theft or administrative error being at fault.

How to calculate inventory shrinkage

Every time you sell an item, the value of your inventory on hand is reduced by the price of that item. Conversely, whenever you place a new order of stock, the value of your inventory increases by the amount you ordered.

Your shrinkage is whatever discrepancies arise between the sales and orders you have recorded and the actual value of the inventory you have on hand.

Let’s say you have Ksh 500,000 worth of inventory according to your records. You do an inventory count and find you actually have Ksh 458,000 on hand. Your inventory has shrunk by Ksh 42,000.

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Check out PART 2:>> Inventory shrinkage management: how to control inventory shrinkage