• Jim Payne

Is inventory shrinkage killing your profits?

The short answer is “YES”. Everybody that has inventories also has some amount of inventory shrinkage. While it’s theoretically possible to account for your inventories perfectly, to do so would be astronomically expensive and hurt your profits more than it would save.


What is inventory shrinkage? It’s the unexplained difference between what a physical count says we have and what the books say we should have. This difference has many causes such as theft, damaged inventory that was discarded, counting errors, and other mistakes such as getting the units of measure messed up or recording a vendor invoice incorrectly.


How to evaluate shrinkage number?

  • Rule 1 – Don’t kid yourself. It’s an easy solution to just classify the shrinkage number as a mistake in the count that will correct itself on the next physical count. Your accounting system is shouting a warning and you need to listen.

  • Put the number in perspective. Annualize the shrinkage amount by taking the percentage of monthly sales and multiplying that by annual sales. This is the number that if you could magically make appear would be in your net profits.

  • The University of Florida has studied shrinkage for many years. Typically, the average shrinkage rate is around 1.5% of total sales. This average includes some big companies that are very good at inventory control. It’s worth their while to spend the money on this in order to be very good. Most small business are on the high side with loss rates running up to 5%. The good news is that if you are on the high side, spending just a little time and money will have a big impact on your bottom line. Set a goal to move that lost percentage down just 1%.

What are some of the cheaper things that you can do to cut your inventory losses? The answers are numerous from improving security to making accounting system improvements. A few ideas are:

  • Employee training – make them more cognizant of shoplifting and what it might be costing the company and their bonuses.

  • Recognize that as much as you appreciate your employees, this problem probably includes theft by them in some manner. Make them aware that there are consequences.

  • Pick 10 high risk inventory items and track them daily comparing a physical count to the records. Chase down any differences and fix the accounting system if it was an error.

  • Reduce the amount of high risk items that you carry. This means ordering them more often in smaller quantities.

  • Automate the inventory control systems using bar code scanner, RFID and surveillance tags. This reduces many accounting errors such as what happens when the customer gets the deluxe widget while their invoice shows the basic version.

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