# Understanding Shrinkage: Causes, Impact, and Solutions in Retail

## What Is Shrinkage?

Inventory shrinkage represents the difference between recorded and actual stock levels. Commonly found in retail, it arises from factors like theft, administrative mistakes, and vendor fraud, leading to profit losses. Realizing the importance of managing shrinkage helps retailers maintain profitability and operational efficiency.

### Key Takeaways

*   Shrinkage refers to the loss of inventory due to reasons such as employee theft, shoplifting, vendor fraud, and administrative errors.
*   The discrepancy between a retailer's recorded inventory and actual inventory on hand is characterized as shrinkage, leading to decreased profits.
*   Retailers often face increased costs, such as additional security expenses, to prevent shrinkage, which can ultimately impact pricing.
*   Shrinkage can pressure businesses to raise prices, burdening consumers and potentially reducing the customer base.
*   Effective management of shrinkage involves regular inventory audits, employee theft prevention training, and enhanced security measures.

## The Importance of Understanding Inventory Shrinkage

Shrinkage is the difference between the recorded (book) inventory and the actual (physical) inventory. Book inventory uses the dollar value to track the exact amount of inventory that should be on hand for a retailer. When a retailer receives a product to sell, it records the dollar value of the inventory on its balance sheet as a current [asset](https://www.investopedia.com/terms/a/asset.asp).

For example, if a retailer accepts $1 million of product, then the inventory account increases by $1 million. Every time an item is sold, the inventory account is reduced by the cost of the product, and [revenue](https://www.investopedia.com/terms/r/revenue.asp) is recorded for the amount of the sale.

However, inventory is often lost due to any number of reasons, causing a discrepancy between the book inventory and the physical inventory. The difference between these two inventory types is shrinkage. In the example above, the book inventory is $1 million, but if the retailer checks the physical inventory and realizes it is $900,000, then a certain part of the inventory is lost, and the shrinkage is $100,000.

## How Does Shrinkage Affect Retail Profits?

The largest impact of shrinkage is a loss of profits. This is especially negative in retail environments, where businesses operate on low [margins](https://www.investopedia.com/terms/p/profitmargin.asp) and high volumes, meaning that retailers have to sell a large amount of product to make a profit. If a retailer loses inventory through shrinkage, it cannot recoup the cost of the inventory itself, as there is no inventory to sell or return, which trickles down to decrease the [bottom line](https://www.investopedia.com/terms/b/bottomline.asp).

Shrinkage is common in retail, and some businesses raise product prices to offset these inventory losses. Higher prices burden [consumers](https://www.investopedia.com/terms/c/customer.asp), making them pay for theft and inefficiencies that lead to product loss. [Price-sensitive](https://www.investopedia.com/terms/p/price-sensitivity.asp) consumers may go elsewhere if shrinkage leads to higher prices.

Shrinkage can also raise other company expenses. Retailers often invest in more security, like guards and technology, to prevent theft-related shrinkage. These costs can cut into profits or raise prices for customers.

## What Are the Causes of Shrinkage?

Shrinkage is caused from the loss of inventory due to shoplifting, administrative error, employee theft, vendor fraud, and broken items, among other reasons.

## How Do You Control Shrinkage?

To help prevent shrinkage, businesses can conduct inventory audits, install surveillance cameras, thoroughly review vendors, and set up theft prevention training for employees.

## How Is Shrinkage Calculated in Retail?

To calculate shrinkage in a retail store, you would look at the book inventory, which represents the inventory received and should be present in the store, and then subtract the actual amount of inventory, which is the amount of goods that are physically in the store.

## How Much Is Lost to Shrinkage Annually?

According to a study from the [National Retail Foundation](https://www.investopedia.com/terms/n/national-retail-federation-nrf.asp), retail businesses lost $62 billion from “shrink” in 2019, amounting to an average of 1.6% of sales.

## What Are Retailers Prioritizing to Reduce Risk of Loss?

Nearly 30% of retailers reported that [ecommerce](https://www.investopedia.com/terms/e/ecommerce.asp) crime has become a much higher priority over the last five years, followed by organized retail crime (ORC) (28%) and internal theft (20%).

## The Bottom Line

Shrinkage, defined as the loss of inventory due to factors like theft, administrative errors, and vendor fraud, poses a critical challenge for retailers. It creates a discrepancy between book and actual inventory, leading to significant profit loss and potential cash flow issues. Retailers can manage shrinkage by conducting regular inventory audits, enhancing security measures, and training employees. By proactively controlling shrinkage, businesses can safeguard their profits, stabilize cash flow, and maintain competitiveness in the market.  

> **Article Sources**
>
> 1.  National Retail Federation. “[Retail Shrink Totaled $61.7 Billion in 2019 Amid Rising Employee Theft and Shoplifting/ORC](https://nrf.com/media-center/press-releases/retail-shrink-totaled-617-billion-2019-amid-rising-employee-theft-and).”
>     
> 2.  National Retail Federation. “[2020 National Retail Security Survey](https://cdn.nrf.com/sites/default/files/2020-07/RS-105905_2020_NationalRetailSecuritySurvey.pdf),” Page 2 (Page 4 of PDF).