Full Guide: Inventory Shrinkage [Overview + Case Study]

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November 20, 2019
by Jonathan Zalman
Read time: 4 minutes


Inventory shrinkage can be extremely harmful to CPG brands and retailers alike, as it represents a direct hit to revenue and gross profits. The following will define inventory shrinkage and explore some key statistics; understand an applied example of inventory shrinkage and its affect on accounting; explore the main causes of inventory shrinkage; and consider how the right software can automate inventory management processes and reduce inventory losses.

What's Inventory Shrinkage?

Inventory shrinkage, or shrink, is an inventory management term that describes a loss of inventory. Inventory shrinkage is the calculated difference between perpetual inventory and the physical count. In other words, inventory shrinkage occurs when the amount of products that are listed in the books (accounting records) is not the same as the actual inventory in the warehouse.

Inventory count discrepancies occur at some point between the manufacture of a product and the point of sale. They can cost CPG brands and retailers major bucks.

According to a recent study, inventory shrinkage cost retailers $100 billion in 2017 alone, or 1.82% of all sales globally, with $42 billion of that figure tied to losses for U.S. retailers. (The retail vertical with the highest rate of losses is fashion and accessories, at 2.43% of sales.)

How Is Inventory Shrinkage Recorded?

Inventory shrinkage needs to be accounted for so that the value of products listed in inventory records can be matched with the physical count. Shrink should be recorded as an expense, which hits your balance sheet in the pertaining financial period.

As companies scale, costs increase. As a result, a reducing shrinkage rate can increase a brand’s profit margin.

Inventory Shrinkage in Action: Case Study

Imagine, if you will, a make-believe CPG brand called Green4Life, which manufactures a line of household cleaning products. They market to green-minded consumers: shoppers who desire a better-for-the-world cleaning product with ingredients they can pronounce, wrapped up recycled (and recyclable) packaging. They charge a premium because they understand that consumers are willing to fork for sustainable products.

Green4Life stores its inventory at two main warehouses, operated by a 3PL: one on the west coast located in San Jose, Calif. and another on the east coast outside of Raleigh-Durham, NC. At its west coast location in central California, Green4Life’s accounting record show that it stores $750,000 of inventory. After conducting a count of physical inventory, however, Green4Life learns that it has $725,000 worth of product on hand.

The amount of inventory shrinkage is $25,000 (or a shrinkage percentage of 3.33%). This number represents Green4Life’ total inventory losses at that particular warehouse. It’s the deficit of what’s listed in accounting records versus what the physical count shows.

What Causes Inventory Shrinkage?

So what happened? Where did that inventory go, and how did it go missing? Or, was it never actually gone in the first place?

In order to create an effective loss prevention plan, and prevent inventory shrinkage, it’s important to understand the major factors that lead to it in the first place. Theft, as detailed below, is the most significant factor of inventory shrinkage for CPG brands and the retail industry at large. It should be noted, however, that there are numerous other culprits that can impact shrink, outside of bad intentions.

The following lists the 5 major reasons why inventory shrinkage can happen:

  • Shoplifting, incl. return and coupon fraud. (Sometimes, customers steal or game the system. If you’re a retailer, this is inevitable.)
  • Employee theft (internal)
  • Human error (Paperwork / administrative / clerical errors)
  • Supplier / vendor / retailer fraud or error
  • Damaged, expired, or obsolete products

How to Reduce Inventory Shrinkage

It begins by having total visibility. The loss of inventory can be prevented by implementing effective, scalable inventory control procedures, aided by software—rather than spreadsheets—that provides a 360-degree view of inventory across all warehouse locations in real time. In fact, inventory management methods that result in a reduction of inventory shrinkage begin with having the right platform with which to run your supply chain. The benefits of the right software should be robust:

  • Track inventory (raw materials, components, and finished goods) for all suppliers, manufacturers, warehouses, distributors, and retails. This database should be searchable.
  • View SKU snapshots, including data about: UOM & UOM cost, expiry date, quantity, and total costs.
  • View logs (in real time or via a date range) that include data related to: quantity, Work in Progress (WIP), slippage and slippage % based on prior day, week, and year.
  • Track shrinkage over time, with transactional inventory.
  • Replenish items; transfer inventory from one warehouse to another; choose lot priority; and adjust inventory amounts (or other data)—all from one platform.

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