It takes a lot of hard work to run an inventory-focused firm. Reducing inventory costs and increasing margins require effective management of inventory loss. Through this article, let’s explore how we can reduce loss and maximize profits by minimizing inventory shrinkage.
What is an Inventory?
The items, materials, or products that a business keeps on hand for sales, distribution, or manufacture are referred to as inventory. It consists of completed commodities, work-in-progress objects, and raw materials. Inventory is an essential asset for businesses, allowing them to meet customer demand, fulfill orders, and maintain a smooth production and sales cycle. In order to reduce carrying costs, avoid stockouts, and increase overall operational effectiveness, businesses must track and manage their inventory.
What is Inventory Shrinkage?
Inventory shrinkage refers to the loss of inventory or stock that occurs between the time it is recorded in the company’s books and the actual physical count. It can be caused by a number of factors, including shoplifting, theft by employees, mistakes in documentation or administration, spoiled or damaged items, and supplier fraud. Inventory shrinkage can have a significant impact on a company’s profitability and operational efficiency, as it results in lost or unaccounted-for inventory that directly affects the bottom line.
Businesses typically conduct regular inventory audits to identify and minimize shrinkage and implement measures such as security systems, employee training, and efficient inventory management practices to prevent and reduce inventory shrinkage.
How to Calculate Inventory Shrinkage?
To calculate inventory shrinkage, follow these steps:
1. Determine Starting Inventory Value: This is the value of all the items you have in your inventory at the beginning of the specified period.
2. Determine Ending Inventory Value: This is the value of all the items you have remaining in your inventory at the end of the specified period.
3. Calculate Cost of Goods Sold (COGS) During Specified Period: This is the cost of all the items you sold during the period.
4. Calculate Lost Inventory Value: Subtract the ending inventory value from the starting inventory value.
5. Calculate Inventory Shrinkage Percentage: Divide the lost inventory value by the COGS during the specified period. Multiply the result by 100 to get the percentage.
Formula: (Lost Inventory Value / COGS) * 100 = Inventory Shrinkage Percentage
What Should be an Ideal Inventory Shrinkage Rate?
The ideal inventory shrinkage rate is zero. This means that there is no loss or shrinkage of inventory within a business. However, achieving a zero shrinkage rate is extremely rare and challenging for most businesses. Various factors such as theft, shoplifting, employee errors, damaged goods, and administrative mistakes can contribute to inventory shrinkage.
While a zero shrinkage rate may not be realistic, businesses should aim to keep their shrinkage rate as low as possible. The acceptable shrinkage rate can vary depending on the industry and the specific business. Typically, a shrinkage rate of around 1-2% is considered acceptable for many retail businesses.
It is essential for businesses to implement effective inventory management and loss prevention measures to minimize shrinkage. This includes using inventory tracking software, implementing security measures like CCTV cameras and anti-shoplifting devices, conducting regular inventory audits, improving employee training, and establishing clear policies and procedures to prevent theft and errors.
Reducing inventory shrinkage assures profitability and guarantees the accuracy of financial records. Keeping the shrinkage rate at an acceptable level helps businesses to optimize their inventory control processes and minimize potential losses.
What Causes Inventory Shrinkage?
There are several common causes of inventory shrinkage, such as:
1. Theft: Employee theft or shoplifting is one of the primary causes of inventory shrinkage. Employees may steal items directly or collude with customers to steal them. However, another significant contributor to inventory shrinkage is shoplifting by customers.
2. Error in Recording: Mistakes in tracking and recording inventory, such as errors in data entry or failure to update inventory records accurately, can lead to inventory shrinkage. This can be due to inadequate inventory management systems or human errors.
3. Damage or Spoilage: Items can be lost or damaged during handling, transportation, or storage. This can include breakage, expiration, or deterioration of perishable goods. Spoiled or damaged products may often not be noticed leading to inventory shrinkage.
4. Administrative Errors: Administrative errors, such as miscounts during inventory audits, misplaced items, or outdated inventory tracking methods, can lead to inventory shrinkage. Inaccurate or incomplete documentation can make it challenging to identify missing items or discrepancies in inventory levels.
5. Vendor Fraud: Supplier or vendor fraud can contribute to inventory shrinkage. This can occur when suppliers send fewer items than ordered or substitute lower-quality items without notifying the buyer. Overbilling or incorrect pricing can also lead to inventory shrinkage.
6. External Factors: Natural disasters, accidents, or unexpected events like fires, floods, or power outages can cause inventory loss.
To address and prevent inventory shrinkage, businesses often employ measures such as implementing strong inventory control systems, conducting regular inventory audits, improving security measures, implementing surveillance systems, training employees on theft prevention, and improving inventory management practices.
How to Avoid Inventory Shrinkage?
Here are some ways to help avoid inventory shrinkage:
1. Implement Robust Inventory Management System: To track your inventory accurately, having a reliable system in place is a must. This system should include real-time inventory tracking, barcoding, and regular inventory audits.
2. Train and Educate Staff: Make sure your employees are aware of the importance of inventory management and the impact of shrinkage. Train them on how to handle and store inventory correctly, promote a culture of accountability, and implement strict security measures.
3. Secure Your Premises: Invest in security measures such as surveillance cameras, access control systems, and security alarms. Limit access to your inventory by implementing keycards or biometric access for restricted areas.
4. Conduct Regular Inventory Audits: Regularly count and reconcile your physical inventory with your system records to identify discrepancies. This will help you detect and resolve issues before they escalate.
5. Improve Receiving and Shipping Procedures: Implement strong processes for receiving and shipping goods, including verifying the accuracy of incoming shipments and inspecting outgoing orders.
6. Identify and Address Problem Areas: Analyze your inventory data to identify high-risk areas or products that are more prone to shrinkage. Focus your efforts on addressing these specific issues by implementing tighter controls and increased monitoring.
7. Implement Employee Controls: Enforce strict inventory handling policies, such as requiring employees to use designated areas for breaks and prohibiting personal belongings in inventory areas. Use surveillance cameras and random audits to deter and catch potential internal theft.
8. Maintain Clean and Organized Warehouse: A cluttered and disorganized warehouse can lead to inventory damage or loss. Keep your warehouse clean, well-lit, and properly organized to minimize the risk of accidents and improve inventory visibility.
9. Review Supplier and Vendor Relationships: Verify the reliability and trustworthiness of your suppliers and vendors. Make sure they have a solid reputation for delivering accurate and undamaged goods.
10. Monitor Sales and Returns: Regularly monitor your sales and returns data to identify any unusual patterns or discrepancies. This can help you identify potential theft or fraud and take appropriate actions.
By implementing these strategies, you can reduce the risk of inventory shrinkage and protect your business’s bottom line.
Key Takeaway
Inventory shrinkage can have serious implications for businesses. By implementing a combination of security measures, inventory control systems, internal controls, efficient management practices, and promoting a culture of accountability, organizations can reduce the occurrence of inventory shrinkage and safeguard their profitability.