6 causes of inventory shrinkage and how to prevent them

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When you check your inventory on paper, or more likely in the computer, it seems you should have a lot of inventory of one particular item—and, yet, as you peruse the shelves or warehouse, you see that it’s not in the quantities you would expect. The numbers don’t seem to add up, and your left asking yourself, what’s going on? That is called “inventory shrinkage” or inventory loss, and it occurs when your books show you have more inventory than you actually do.

In fact, there’s a way to calculate exactly how much inventory shrinkage you have through a simple calculation.

Here’s how to find your inventory shrinkage percentage.

First, conduct an inventory of your goods, then calculate the total cost. Subtract this amount from the cost listed in the accounting records. Then, divide the difference by the amount in the accounting records.

It’s wise to establish a baseline, and then conduct a similar tally on an ongoing basis to see if changes you’ve put into place have paid off, or if an alarming new amount of shrinkage could indicate a new problem. If you are a retailer your inventory is the key to your success and inventory management is key to making sure your profits aren’t lost.

Let’s look at Six ways inventory shrinkage happens and how you can prevent it. Here are the various causes of inventory shrinkage:

Inventory shrinkage cause 1: Employee theft

What it is:

Believe it or not, the Association of Certified Fraud Examiners estimates that businesses lose 5% of their annual revenue to employee fraud and abuse. And, while you might think that big business bears the brunt, it’s actually more prevalent in small business.

How to prevent it:

The best defense is to check your books and inventory regularly so that you have an accounting of your physical inventory and are aware of small problems before they become big. Aside from that, there are as many ways to prevent theft as there are to steal stuff. They can vary from overly laborious to too lax, so you will have to be the judge about which of these tactics works best for your business.

  • Have a single entry and exit point so employees can’t shuttle goods out the side doors.
  • Use cameras to record employee movements.
  • Conduct bag checks at the end of the day.
  • Track staff logins via a point-of-sale system (POS system) to help identify loss patterns.
  • Use clear plastic trash bags so it’s harder to smuggle items out with the trash.
  • Carefully track all discounts so that employees aren’t awarding fake discounts and pocketing the difference.
  • Make sure that all employees take vacation so you can notice any patterns when someone is gone.
  • Rotate jobs frequently.

Inventory shrinkage cause 2: Customer theft

What it is:

We all know what this is: It’s when customers help themselves to the goods without paying for them, and as you might expect, it’s the #1 cause of loss in retail environments, according to the National Retail Foundation.

How to prevent it:

As with employee theft, it’s up to you to decide how heavy your hand will be to deter shoplifting, whether it’s prohibiting backpacks or installing surveillance cameras or mirrors. But, keep in mind that one of the best deterrents to theft is also a fantastic way to boost sales—top-notch customer service.

When your employees are actively engaging with visitors, they are going to decide there’s less opportunity to get away with a crime because they are being watched—by a helpful salesperson. A shoplifter can be thwarted by a company being proactive.

Here are two other suggestions:

  • Implement return policies that require a receipt or other proof to deter customers from trying to profit from returning stolen goods. Or, if you suspect an employee is in on the scam, suggest a restocking fee.
  • Use a system like barcoding that discourages easy tag switching, where a customer swaps tags, putting one from lower-price goods on a higher-priced item. Not only is it a way for customers to get cheaper goods in retail businesses, but it can also throw your inventory system and inventory control into disarray with not one, but two misrepresented items.
  • If your problem is getting out of hand, consider employing a Loss Prevention professional to help evaluate your business practices and location for areas of increased vulnerability.

Inventory shrinkage cause 3: Human error

What it is:

Just a mistake … but, it can be a costly one. Maybe, someone was tracking incorrect units of measure, left out a decimal point or put it in the wrong place. Or, maybe they miscounted as they were tracking and tallying inventory, thus logging the wrong number. This can be an honest problem and simply an administrative error—or it can be an employee trying to pull a fast one.

How to prevent it:

Double checking your actual inventory—through counting and recounting—is essential, even if you rely on automation. And, make sure to combine that with tight controls, which can help minimize miscounting. For example:

  • Create a process that minimizes the potential for miscounting—for instance, physically moving stock from one place to another as you count it, or using smaller units of measure.
  • Have two people check inventory to compare figures. This also eliminates the chance that an employee will fraudulently report inventory numbers and later steal something.
  • Make inventory counting shifts short so that people don’t lose focus.
  • Double-check all figures by someone with a fresh eye, helping prevent loss of inventory.

Inventory shrinkage cause 4: Damage

What it is:

Damaged goods can happen by accident or in other cases because someone —whether—an employee or guest, is careless.

How to prevent it:

Some damage is inevitable, but minimizing it is possible.

  • Employee training can be helpful, especially if you are working with particularly delicate items. Show your team how to properly unbox, store, and otherwise handle parts or goods that are particularly prone to damage.
  • Implement a policy to inspect damaged goods, rather than just having an employee dispose of them. This allows you to salvage what you can and also minimizes fraud.
  • Maintain your environment well, so that goods aren’t damaged through incidents like leaks or a rodent infestation.
  • Consider how to handle guest damage—for example, will you go with the ubiquitous gift shop “You break it, you buy it” sign, informing customers that damage is on their dime?

Inventory shrinkage cause 5: Supplier fraud

What it is:

In this scenario, you think you have more inventory than you actually do because your supplier has promised a certain amount—and billed you for it—yet didn’t actually deliver all the goods. Therefore, your physical count was off.

How to prevent it:

Having trusted suppliers is important, but even long-standing relationships can come under fire because of one errant employee, so you need to be vigilant.

  • Make sure that someone is physically counting all the boxes that arrive and compare them to the bill of sale.
  • Remember that time is of the essence—it’s much harder to report a potential loss after time has passed.
  • Create a policy so you are not making full payments before the goods have been inspected.

Inventory shrinkage cause 6: Spoilage or waste

What it is: 

In the case of food products, inventory could shrink because food gets old or otherwise deteriorates and cannot be sold, or in the case of a restaurant scenario, the ingredients can’t be used.

Another problem arises when employees are not properly following recipe guidelines. For example, if you have X number of pickles, assuming that each plate gets two and an overzealous server is adding four, you will end up with fewer pickles at the end of the week than expected.

How to prevent it:

Spoilage and waste is not only a money loser, but it’s also bad for our environment. Here are some best practices:

  • Supplement employee training with ongoing process updates regarding best practices for serving food items and using specific ingredients.
  • Spot-check plates and pouring techniques to ensure that everyone is properly following procedures.
  • Deploy a restaurant POS that will help track what’s being ordered to help with inventory and allow you to spot disparities that can be narrowed to specific shifts.
  • Use a FIFO (first in, first out) process to ensure you are using the older food first. Make it a priority to rotate stock when new shipments come in.
  • Keep a close eye on food freshness and promptly use older ingredients that are at risk of spoiling. If it’s a grocery store, you could offer them on special, or if you run a restaurant, you can incorporate them into a special dish.

Stop shrinking inventory before it leads to shrinking profits

Inventory shrinkage is a real problem for most SMBs, and can affect your bottom line. The good news is that there are some great strategies for preventing nearly all of these causes. The first step is encouraging a culture of openness, this can go a long way to minimizing inventory shrinkage.

Stay vigilant when comes to your inventory, think of every item on the shelf is dollar in your pocket. Some theft or loss is inevitable, but letting shrinkage go unchecked can put your profits in peril.

This article was produced by the Quickbooks Resource Center and syndicated by MediaFeed.org.

Featured Image Credit: DepositPhotos.com.