Shrinkage is the inventory lost due to shoplifting, internal theft, damaged goods, or administrative errors done at retail stores.
Every year, quarter or half year the retailer conducts a stocktake to track all the existing inventory and then compare it with the value of ending inventory in the books (on the balance sheet). The difference between the two values represents the shrinkage and is expressed as % of total sales for the same period.
Retail Shrinkage Formula
To calculate shrinkage in retail you will need the existing inventory value on the balance sheet and the total sales for the period between the last conducted stock count and this stock count.
Then you get the value of the stock from the current stock count and use the below formula to calculate shrinkage
Shrinkage % = (Value of Lost Stock ÷ Total Sales for the period ) x 100
You conduct a stock count and get a total stock value of 125,000 $ at cost
Your stock value in the books is 140,000$ (at cost)
Your sales for the period between last stock count and this stock count are 500,000$
Stock loss = 140,000$ – 125,000$ = 15,000 $
Shrinkage( %) = (Value of Lost Stock ÷ Total Sales for the period ) x 100
Shrinkage (%)= 15,000$ ÷ 500,000 x 100 = 3%
The way described here is called Cost to Retail, where lost amount is calculated at cost value and the total sales are taken at retail value.
Some retailers prefer to report Retail to Retail or Cost to Cost. This is simply by following the same procedure and formula but calculating the lost amount and the sales at either both at cost or both at retail value.
Download our free retail math formulas cheat sheet and excel calculators, which include shrinkage calculations.
What Causes Inventory Shrinkage in Retail Businesses?
The biggest contributors to retail shrinkage are:
1. Administrative Errors
This could be in the form of wrong receiving procedures or wrong counting at the stock count event. These errors will result in inaccurate stock levels being on the system or inaccurate count of the actual stock in the store.
This will result in a discrepancy between the book value of the stocks and the counted value and will be reported as shrinkage.
Most of these losses are not real losses, however, because the stock is actually there and not missing. Usually in the next count the results will reflect as up & down in the report, where the lost item will be showing now as an extra item.
Another admin error could be mislabeling products, resulting in some products being sold while other products being reported on the system instead. This will also result in an up & down in the same report between the different SKUs and if the product prices were different it can result in actual losses of revenue as well.
2. Internal Theft
This is the portion of shrinkage attributed to store employees or warehouse employees theft. Unfortunately this is one of the highest contributors to retail shrinkage.
Such theft can happen as direct product theft or stealing from the cash counters by giving the item to the customer but not ringing it on the cash till. The product will still be on the inventory records, but it is not actually in the store.
3. External Theft
This is basically shoplifting by customers of the store or as a result of some type of vendor fraud. This can happen by direct shoplifting of the product by the customer or by implementing some sort of return or exchange fraud, where products that have not been bought are returned at the cash desk and a refund is issued to the customer.
How to Minimize Inventory Shrinkage in Retail Businesses?
Shrinkage is one of the metrics that a retail manager can try and improve it easily, and reap the benefits of this directly in their P&L.
Having said that, no retailer expects to have 0% shrinkage.. it is almost impossible. Usually there is a target set by the company each year, and companies that achieve that target try to improve their process even further to reduce it more.
Here are some of the areas to work on, in order to reduce shrinkage in retail.
Creating a Stock Loss Action Plan
The first step to control inventory shrinkage is to perform an audit for all the risk areas that contribute to shrinkage at the store, and based on the findings draft a stock loss action plan.
You will create a list of areas to be monitored, where certain procedures should be followed on a regular basis. Then you will go through those points one by one and give your store a rating (R/A/G for Red/Amber/Green).
After performing the audit, you will then summarize the areas where your store received a Red rating and create a stock loss action plan that addresses those areas and assigns responsibilities and timeline for your team to action them.
You will also define a review date, where you will go through those points again to see if they have been actioned.
You can download the above stock loss action plan and the audit check list for free from the link below
Usually retail shrinkage can be minimized by applying proper procedures to be followed by employees and training them to be able to administer everything accurately. For example you will find that a main contributor to high shrinkage in retail is actually basic admin errors (almost 20%). This can easily be avoided by training retail employees on the correct receiving procedures and correct labeling of products.
Another way to minimize shrinkage is by analyzing the report and checking the most common products that have gone missing. Then check their area on the floor to see if there are CCTV cameras in place and whether you could focus on them with the camera, as well as by training your staff to regularly check this area.
Another practice is also to conduct perpetual counts on some products on a regular basis. This pro-active approach will help you identify risk areas early and will also send a message to your employees that you are being alert and focused on reducing your shrink.
Having The Right Culture
Since almost 30% to 35% of retail shrinkage is a result of internal theft, we strongly believe that hiring the right people, compensating them fairly and having the right culture to retain them will greatly improve any business’ shrinkage results.
We have seen huge reduction in shrinkage at our retail stores, just by hiring people with ownership mentality and giving them the right path to career development.
Why Is Inventory Shrinkage an Important KPI ?
Inventory shrinkage is an important KPI in retail because of its effect on your retail P&L is high, since it affects your gross margin directly. Also inventory is the biggest asset on a retailer’s balance sheet, and so even a small percentage of this number usually translates into a high amount of lost asset value.
Retail profit margins in general are thin, around 5-7%, if the company is good, and much lower for discount retailers and grocery stores (see also Retail Benchmarks) .When you look at a 2% shrinkage you start realizing that you are losing a big part of your profits to something that can be fixed with a little bit of discipline.
Read More: P&L Management
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