What Is Shrinkage?

Shrinkage is the loss of inventory that can be attributed to factors such as employee theft,
shoplifting, administrative error, vendor fraud, damage, and cashier error. Shrinkage is the
difference between recorded inventory on a company’s balance sheet and its actual inventory.
This concept is a key problem for retailers, as it results in the loss of inventory, which
ultimately means loss of profits.

Why Is Understanding Shrinkage Important?

Shrinkage is the difference between the recorded (book) inventory and the actual (physical)
inventory. Book inventory uses the dollar value to track the exact amount of inventory that
should be on hand for a retailer. When a retailer receives a product to sell, it records the dollar
value of the inventory on its balance sheet as a current asset.

For example, if a retailer accepts $1 million of product, then the inventory account increases by
$1 million. Every time an item is sold, the inventory account is reduced by the cost of the
product, and revenue is recorded for the amount of the sale.

However, inventory is often lost due to any number of reasons, causing a discrepancy between
the book inventory and the physical inventory. The difference between these two inventory
types is shrinkage. In the example above, the book inventory is $1 million, but if the retailer
checks the physical inventory and realizes it is $900,000, then a certain part of the inventory is
lost and the shrinkage is $100,000.

What Is the Impact of Shrinkage?

The largest impact of shrinkage is a loss of profits. This is especially negative in retail
environments, where businesses operate on low margins and high volumes, meaning that
retailers have to sell a large amount of product to make a profit. If a retailer loses inventory
through shrinkage, it cannot recoup the cost of the inventory itself as there is no inventory to
sell or inventory to return, which trickles down to decrease the bottom line.

Shrinkage is a part of every retail company’s reality, and some businesses try to cover the
potential decrease in profits by increasing the price of available products to account for the
losses in inventory. These increased prices are passed on to the consumer, who is required to
bear the burden for theft and inefficiencies that might cause a loss of product. If a consumer
is price sensitive, then shrinkage decreases a company’s consumer base, causing them to look
elsewhere for similar goods.

In addition, shrinkage can increase a company’s costs in other areas. For example, retailers
would have to invest heavily in additional security, whether that investment is in security
guards, technology, or other essentials, to prevent shrinkage that was caused by theft. These
costs work to further reduce profits, or to increase prices if the expenses are passed on to the
customer.
Types of shrinkage in retail
To help you identify and eliminate retail shrinkage, here are some common types of retail loss
and how to prevent them:

Shoplifting
Shoplifting is when external individuals—people who don't work for the company—steal
inventory from a retail store. Shoplifting can take a variety of forms and can include items of
varying worth. For example, a shoplifter might operate individually to steal an item worth a few
dollars, or a team of shoplifters might coordinate to steal many items worth much more. They
may hide items on their person, such as a small item hidden in their pocket, or use other methods
like swapping price tags and moving high-value items into a box for a low-value one.
In any form, a shoplifter might commit this infraction once, or many times. Whatever form it
takes, shoplifting can contribute to significant inventory loss and, therefore, lost revenue and
decreased profits.

Employee theft
Employee theft occurs when individuals associated with a business steal from or defraud the
company. This form of retail shrinkage can take a variety of forms as well. Sometimes,
employees engage in outright theft by removing items from a retail store. Other times, employee
theft might take the form of fraud such as intentionally mischarging an accomplice.
Return fraud
Return fraud occurs when someone steals a product and then returns it for a refund. It can also
occur when a used item is returned for a refund against store policy, or if an item was purchased
using counterfeit currency and returned for a refund. Return fraud can be hard to track because it
can happen in many different ways, and effective employee enforcement of return policies can
help.
Administrative errors
Administrative errors, sometimes called human errors, are mistakes in the accounting process
that cause a discrepancy between expected and actual inventory during an accounting period.
Typos, mislabeled merchandise and erroneous discounts can all contribute to this accidental type
of retail shrink. Although these kinds of errors aren't intentional, they can impact a business's
revenue and profitability.
Operational loss
Operational loss, or waste, refers to the kinds of losses that are generally accidental and only
sometimes preventable. For example, merchandise that is broken in the store might be
considered an operational loss. Expired food products are another form of operational loss. Many
businesses account for operational loss as to be somewhat expected in the course of doing
business, but it can be beneficial to minimize this kind of shrink as well to help boost revenues
and profitability.

How to prevent retail shrinkage

Here are some steps you can take to prevent each type of shrinkage listed above:

Preventing shoplifting
Here are some ways you can prevent shoplifting retail shrink:
High-quality customer service: The principles of good customer service, such as engaging with
each individual in the store, checking in often and staffing all areas of a store can help reduce
shoplifting shrink because visitors are probably less likely to steal if they know employees are
watching.

Clear lines of sight in retail spaces: Structuring retail spaces in such a way that staff can see all
areas at all times can also help reduce shoplifting shrink. Potential shoplifters are less likely to
take unpaid-for merchandise if they are being observed.

Electronic anti-theft measures: Systems and devices such as security cameras and anti-theft tags
can help mitigate shrink when direct supervision is less feasible—for instance, at times and
locations with fewer staff members on duty or complex retail spaces without clear lines of sight.

Obvious signage: Signs that explain your anti-shoplifting measures, such as security cameras,
and the penalties for shoplifting might deter would-be thieves.

Secured high-value items: Valuable items that can be easily removed from a retail space can be
secured using locked boxes or tethering systems. This can be a useful strategy for items such as
jewelry, electronics and other small but expensive items.

Preventing employee theft

Here are some things you can use to try to prevent employee theft:
Perform background checks: Carefully screening your employees ahead of time can help prevent
employee theft by increasing the likelihood that new hires will be conscientious and display
integrity. Although past instances of theft might not mean an employee will steal from your
company as well, employee theft can sometimes be a habitual behavior.

Train employees thoroughly: Training employees in your expectations regarding matters such as
employee discounts, customer service for friends and relatives and general cash handling can
help prevent employee theft by establishing clear guidelines. Consider making consequences for
employee theft clear in your training process as well.

Emphasize accountable store culture: Employees who enjoy a positive workplace culture may
feel more invested in the company's success, which could make them more likely to show
integrity on the job. This can, in turn, reduce shrinkage through employee theft.

Transparent inventory handling systems: Establishing norms such as varied closing teams and
even using clear trash bags can mitigate employee theft by encouraging honesty each time
inventory moves.

Preventing return fraud

Here are some ways you may be able to prevent return fraud:
Require a receipt for returns: A receipt usually proves that an item being returned was purchased
legitimately and not stolen. This means requiring a receipt with returns can help prevent return
fraud.
Track ID with returns: Requiring customers to show ID to process a return can also help mitigate
return fraud. If employees check ID before authorizing a return, they can better watch for people
who may return items excessively or suspiciously.
Train employees on return fraud: Since employees are the individuals most likely to interact with
people trying to engage in return fraud, it can be useful to train them in best fraud prevention
practices. Be sure to stay apprised of recent trends in fraudulent practices and ways to stop fraud,
and integrate this knowledge into your training materials.

Preventing administrative errors

Here are some ways you might be able to minimize administrative errors:
Thorough employee training: Training employees in best practices in store procedures such as
merchandise labeling and cash handling can help mitigate loss through employee errors. You
might also choose to audit cash handling processes and incentivize good performance.
Inventory monitoring and management: Tools like point-of-sale (POS) software can help you
watch for accounting errors as they occur or soon thereafter, which can then allow you to
implement additional training or leverage electronic tools to make your sales records more
accurate.

Preventing operational loss

Here are some ways you can try to minimize operational loss:
Employee training: Teaching employees how to carefully handle inventory in accordance with
best practices in your industry can help minimize shrinkage that is a result of broken or damaged
inventory.
Thoughtful inventory management processes: Careful operating procedures for tasks such as
ordering food items and other perishables can help minimize shrinkage by operational loss and
waste.