Inventory Shrinkage – Meaning, Causes & Prevention

inventory shrinkage

If you’re a wholesaler or a retailer dealing with substantial goods, there’s a lot of responsibilities at your end.

Dealing with material products has its own pros and cons. It’s no picnic to manage all that stuff! And keep track of all the products in the system.

So you’ve got to be on your toes and identify methods to avoid the occurrence of different types of unfavorable events.

Today, we’re gonna learn about inventory shrinkage. 

What is Inventory Shrinkage?

Inventory shrinkage means the depreciation in the amount of actual inventory from the total that’s recorded in your books.

It means loss of goods due to several things like theft, natural causes or managerial errors. This physical loss directly affects your profits. They must be minimized in order to make sure everything is on the same page.

What Causes Inventory Shrinkage?

Inventory shrinkage is the displacement of the stock between the time of buying goods from the wholesaler (manufacturer) and selling it to customers.

Tracing the roots of the cause is extremely important for preventing further losses.

There can be a number of reasons for the disappearance of stock in the supply chain.

Some of these are mentioned below:

1. Sloppy Documentation of Warehouse Products

Even minute deviations in the records of the warehouse can result in major deficits in profit.

When receiving shipments, make sure that both quantities ordered and delivered are in sync with each other. If the quantity ordered is generally large, minor deficiency in every shipping hints at vendor fraud.

Record variations can be accidental or, worse, a conspiracy against your company! Fake purchases, shipping fraud, and other such scams involve forgery in entries made.

So keep a trail of the errors in the warehouse documentation.

2. Employee or External theft

Stealing can be an insider or an outsider’s job.

Since internal controls are easy to impose, keeping a check on your employee activities is well advised.

These fraud methods involve fake sales where the quantity or price of a product is changed to generate individual profit over the company’s profit.

No business is safe from external theft. Breaking and entering in the warehouse premises and stealing a considerable amount of goods is statistically the biggest reason for inventory loss.

To avoid such unfortunate incidents strict security measures must be adopted.

3. Natural or Accidental Damage

Sometimes natural calamities can ruin stocks. Even a normal roof leak can cause damage. Water-logged goods get damaged due to improper maintenance of the warehouse.

Thus, sub-standard storage areas and unskilled workers can make the company take a hit due to inventory shrinkage. Violent storms can destroy the whole warehouse; these are examples of natural losses.

Alternatively, inventory may get crushed or broken during the shipping process or from movement inside the storage area. Rodents or other insects can infest perishable goods, thus proper sanitation is important.

Finally, improper handling by forklifts can lead to damaged goods. So skilled workers are required for every job in the warehouse to minimize the losses.

Prevention of Inventory Shrinkage 

1. Eliminate Human Errors

To remove human errors from document entries, which may be accidental or deliberate, remove the humans from the scene!

This means automating the data entry process and keeping track of records by use of inventory software.

This helps in individually watching each employee and their transactions. 

Thus, any unusual conduct does not go unnoticed and the margin of error is almost zero.

2. Tighten Security Around the Premises

  • Install cameras covering every part of the business area to evade any misfortune under your nose.
  • Provide access to certain areas to authorized personnel only.
  • Control entry in critical areas by swipe card technology and get an audit trail of people’s movements.

3. Reliable Employees must be Appointed to Deal with External Agencies

A thorough background check must be done before the hiring process.

Sometimes an insider collaborates with an external agency to frame events which harm the company.

Only authentic, verified workers should be designated to supervise entries on shipments delivered and received because the window of cheating is very considerable at those points of business.

4. Run Through Each Day’s Transaction in front of your Associates & Employees

This is to make sure that details are precise and also to make it apparent that the probability of any trickery going unnoticed is almost negligible.

Make a regular estimate of your physical inventory at small intervals to analyze the shrinkage percentage. You can use a Bluetooth scanner to perform the physical count.

Then run the report to check any discrepancy between the original order and the physical count.

5.  Company Policies related to Shrinkage

Educate your employees about the latest fraud trends and thus prevent them from being fooled.

Make them understand that when the company takes a hit due to shrinkage, they are going to share the damage and losses as well!

In this way, they will put maximum effort to avoid any glitches or errors on their part.

6. Standard Hygiene is of Utmost Importance for a Healthy Storage Area

Negligence in sanitation increases the deteriorating rate of the goods stored and reduces their storage time.

Well-organised inventory lasts long and thus haphazardness must be removed from the warehouse.

Keeping Record of the Loss

Since shrinkage can be minimised by taking certain precautions but it cannot be completely eliminated. Thus, to deal with the after-effects of shrinkage these following methods are enforced:

  1. In the case of small loss of goods like theft, etc. you can increase the cost of goods sold to cover the shrinkage deductions. For natural calamities or a huge loss, debiting your cost of sold goods account can cause an oversize hole in the finance sheet. Thus for massive damage, you might prefer to create an expense account specifically for documenting shrinkage losses. This way your gross profit remains unaffected by this unexpected loss.
  2. Prevention is better than cure. Being one step ahead of the game makes you different from your mediocre competitors. This method involves setting up a shrinkage reserve which accounts for the loss of stock. You must have a statistical study of your shrinkage losses in previous years to decide an estimate for the reserve. Thus when any stock-misplacement takes place, the reserve is put to use.


We’ve just thrown light on the causes of shrinkage in a business and actions to prevent these losses. Even if you are extremely careful in conducting your business, inventory shrinkage is inevitable!

Thus, the only way to shield your business against this is to always stay on the lookout. With reliable employees, the risk of an internal rip-off is diminished. Keep the structure well-organized and ensure that job-division and security are flawless.

These steps will help you to lessen your shrinkage losses and that gross profits will always be healthy.

Good luck!