How to Calculate Inventory Shrinkage for Your Business

Inventory shrinkage refers to the difference between the inventory value recorded in a company’s accounting records and the actual physical inventory on hand. Understanding inventory shrinkage is important for businesses to accurately assess their financial health and evaluate the efficiency of their operations. It directly impacts profitability because lost inventory represents a cost incurred without corresponding revenue.

Gathering Necessary Data

Calculating inventory shrinkage requires two primary data points: the recorded inventory value and the physical inventory value. The recorded inventory value is the total worth of inventory a business’s accounting system indicates should be present. This figure is typically derived from perpetual inventory systems, which continuously update inventory balances after each purchase and sale transaction.

Accounting software and enterprise resource planning (ERP) systems maintain these detailed records, reflecting the cost of goods acquired. The valuation method used, such as First-In, First-Out (FIFO), Last-In, First-Out (LIFO), or weighted-average cost, influences this recorded value.

The physical inventory value is the actual worth of products physically counted and verified within the business’s possession. This value is obtained through periodic physical counts, where staff manually count all items in storage, or through cycle counting, which involves counting subsets of inventory on a rotating basis. Conducting these counts often requires temporarily halting other operations to ensure accuracy. Using tools like barcode scanners can improve efficiency and reduce human error during physical counts.

Performing the Calculation

Once both the recorded inventory value and the physical inventory value are determined, calculating inventory shrinkage involves a straightforward formula. The formula is: (Recorded Inventory Value – Physical Inventory Value) / Recorded Inventory Value 100%.

To illustrate, consider a business with a recorded inventory value of $100,000 in its accounting system. After conducting a comprehensive physical count, the actual inventory on hand is valued at $95,000. The first step involves finding the difference between these two values: $100,000 – $95,000 = $5,000.

Next, divide this difference by the recorded inventory value: $5,000 / $100,000 = 0.05. Finally, multiply this result by 100 to express it as a percentage: 0.05 100 = 5%. This 5% shrinkage rate indicates that 5% of the inventory, by value, is missing compared to what the records show.

Factors Contributing to Shrinkage

Various factors can lead to inventory shrinkage, causing the discrepancy between recorded and physical stock. Theft is a significant contributor, encompassing both external shoplifting and internal employee theft. Shoplifting involves customers taking merchandise without payment, while employee theft can range from small item pilferage to more organized schemes, often accounting for a substantial portion of losses.

Administrative errors also play a role in shrinkage, often stemming from unintentional mistakes in record-keeping. These errors can include incorrect data entry, miscounts during receiving or shipping, or pricing discrepancies. Such inaccuracies can lead to an overstated recorded inventory value.

Damage and spoilage represent another common cause of inventory loss. Items can become unsellable due to breakage during handling or storage, or they might expire, particularly with perishable goods. Environmental factors, such as temperature fluctuations or humidity, can also render products unusable, contributing to shrinkage.

Vendor fraud is a less common but impactful factor, occurring when suppliers intentionally or unintentionally deliver fewer items than invoiced or provide incorrect products. This creates a discrepancy where the business pays for goods it does not receive, leading to recorded inventory values that do not match the actual physical count. Regular reconciliation of invoices with received goods helps mitigate this issue.