What is Inventory Shrinkage?

Updated on :June 09, 2024
By :Chris Machetto

Inventory shrinkage involves a loss in inventory value and includes items damaged or lost during the storage and shipping process. Actual stocks minus your recorded stocks constitute Inventory shrinkage. Hence, inventory control becomes an essential aspect of business activity, failing to incur losses worth millions. Even the higher management has to face a lot of inconvenience such as accurate calculation of items left in the stock. To minimize the inventory shrinkage, companies should plan to invest in the best inventory management software systems. The tool enables businesses to accurately track inventory and goods in real-time, minimize costs, and improve product visibility. 

Inventory management is crucial for every business enterprise, but its necessity becomes paramount in the retail and e-commerce industries. It is because it deals with stock items and goods worth millions of dollars. Thus, it becomes more than essential to ensure that the correct items are sold to the right people – at the right time and for the right price. 

Root Causes of Inventory Shrinkage 

Inventory shrinkage is a threat to every business regardless of the scale, and it can affect your business's growth. It may happen at all levels of supply chain management – from storage facilities to shop floor to receipts. However, today almost every industry is vulnerable to this, especially companies that deal in daily consumer goods and eatables.

To effectively minimize inventory shrinkage, an organization must first identify the root causes of such a loss. The most common reasons are:

Employee Theft

Employee theft is one of the prime reasons that leads to shrinkage in the inventory. Employees steal items from the stock or commit burglary, which may be difficult to recover. Also, workers may work out a scheme with external parties. Unidentified persons may take advantage of easy entry into warehouses and storage rooms. Security negligence on the part of management becomes vulnerable to theft. 


Retailers and businesses have to incur huge losses due to shoplifting incidents, identified as the main cause of inventory shrinkage. It is one of the classic examples of why businesses have to suffer inventory loss. It mainly happens due to inadequate security. Shoplifters purchase goods and return them for a refund while receiving cash back without paying for them. 

Error in Calculation 

If you are still using manual practices to track and stock inventory, the chances of getting errors in calculation become more probable. Also, the use of manual spreadsheets can lead to a paperwork error. It further results in inadequate forecasting while preparing the reports and depicting sales trends. 

Vendor Fraud 

There are times when you may find that mismanagement has occurred in the supply chain process and the third-party vendors are committing fraudulent activities. It also leads to inventory shrinkage, which mainly happens during the transit of products. It may also happen that suppliers are resorting to unethical practices, such as selling fake or substandard items or mislabeling the inventory goods. 

Fraudulent Online Payments 

Anyone can easily access the online payment portal with fraudulently trusted credit cards trying to get away with high-value goods to resell to online marketplaces or even on the street; it is also popular in industrial areas where there are warehouses and storage facilities. 

Inventory Shrinkage Can Happen at Various Levels Including

Stock-outs - When stock runs out of certain products due to insufficient stocking, it results in increased customer frustration and dissatisfaction for products not available on time, especially when demand is high.

Product Substitution - When the customer receives a wrong product or incomplete order, it leads to dissatisfaction and customer complaints.

Inaccurate bills -  Bills are inaccurate; there might be some missing or duplicated values in the item description, leading to loss due to vendor disputes.

Returns - If customers receive wrong items, they usually return them. The company has to incur a loss of capital and even have to spend more money on customer service by taking back those items and restocking them again. The cost of shipping also increases. 

Sales fraud - Involves workers stealing stocks for resale in other markets or their consumption – known as a diversion (for example, personal use). 

Diversion – Involves staff diverting goods before they arrive at the warehouse for sale elsewhere, either in person or online. Fraudulent returns where cash refunds are sought using products that have already been returned without a receipt. 

How to Curtail  Inventory Shrinkage? 

Inventory shrinkage can create severe losses if left unattended for long periods. The companies also have to cope with the financial crisis especially when dealing with large manufacturing units directly. Let’s look into the steps that prove effective in minimizing and curtailing inventory shrinkage. 

Periodically Checking the Stock of Goods

The first step towards reducing inventory shrinkage is to check what goods are getting stolen and make a complete list of those items, including the quantity. Next, you should categorize all those items under-protected category. You can look to install hi-tech surveillance systems at your company's warehouse or retail store. Companies have started installing anti-theft alarms and electronic door locks, which can only be opened through a particular code or password. 

Get Insurance to Cover Each Item in Stock

One has already discussed the significance of inventory control and how to deal with it to accomplish maximum investments. Also, when it comes to mitigating inventory shrinkage, you can opt for insurance cover for every item in the stock. The incurance value is usually calculated based on the type of inventory. It includes First-In-First-Out (FIFO), Last-In-First-Out (LIFO, Weighted Average, and Specific Unit. 

Another vital factor determining insurance coverage is how much stock fluctuates over a specific period. An insurance company inspects mainly two things; damage of items during the transit or handling process and damage that occurred due to Acts of God or natural disaster. 

Effective inventory prevention methods are cost-efficient. They also play a critical role in increasing your revenue over time and eventually growing your profits. Hence, don't invest only once; keep investing in new ways to prevent inventory shrinkage every year. 

Involvement of all stakeholders

Involving everyone from top management down to production floor supervisors in finding solutions for such problems can help deal with the issues more effectively. 

Effective communication

Effective communication between the higher management and employees helps reduce employee theft or sabotage. This also allows the management to ensure that all employees understand their roles and responsibilities regarding loss prevention on production floors and in storage rooms, loading docks, and office areas. Good communication between various tiers within supply chains can have multiple benefits, including reducing overall costs by enabling better forecasting, stock maintenance, etc.

Training programs

Training programs for all stakeholders (including supervisory staff) regarding identifying fake products or unauthorized personnel trying to access storage areas can significantly help reduce inventory shrinkage. Such training sessions also help employees frame effective responses during emergency situations. Employees are more likely to respond quickly and learn to handle such situations with confidence when they have adequate training and experience to tackle them. 

Efficient Inventory Control 

A robust Inventory control ensures proper security measures for each item in stock to nullify damage or eliminate all possibilities of items getting stolen when held by the company. Large organizations and manufacturing companies have a separate shipping department packed and shipped to retailers or wholesalers. Some enterprises outsource all shipping operations to logistic firms specializing in warehousing, transiting products, and delivering the items at the doorstep. Inventory control must be done meticulously as it may go wrong for various reasons, such as theft, human error, or damage to the items during transit - those are things you do not have control over. Automating the entire process can save time, money, resources, and inventory shrinkage to a greater extent. 

Best Way to Avoid Inventory Shrinkage:

Investment in Inventory Management  Software

It is one of the most effective steps for reducing inventory losses. Still, the vital factor here is selecting an appropriate inventory management system that comprehensively suffices the needs of the business enterprise and helps improve the overall organization’s security with accurate monitoring and tracking of goods. Using cloud-based storage systems which provide encryption or strong password protection also ensures that unauthorized access to data is not possible, thus ensuring a higher degree of safety with reduced risk of inventory loss due to hacking attempts.

Inventory control software helps companies become proactive by performing regular checks on inventories and their suppliers before receiving materials/products within their premises. The tool even identifies any flaws/deviations, which can be easily rectified. 

Such software also assists companies in keeping track of previous records regarding inventory count and helps allocate workforce to check storage areas for discrepancies.

Also, enterprise resource planning tools can help companies track inventory loss prevention efforts by dealing with only genuine suppliers and optimizing their resources. The software also records all inventories, allowing authorized personnel to perform regular checks without fear of missing anything out and immediately identifying any unusual changes.

Some Other Vital Tips to Minimize Inventory Shrinkage 

In addition to the above-mentioned steps, you can also implement and follow some other vital tricks to mitigate inventory shrinkage. These include-

  • Hiring security guards is a sure way of dealing with external theft. 
  • Improving employee monitoring measures can minimize internal theft and replace trust and confidence in employees' ability to do their jobs well.
  • Monitoring suppliers more closely is also a good idea. Ensuring that all materials, components, and finished products are authentic by testing them at every production stage can help minimize inventory shrinkage caused by suppliers.
  • Enhance your control over product movements within your supply chain with UPC Barcodes. In addition, verify products through serialization and RFID solutions that scan critical data elements at each step along the supply chain. It helps to find any misplaced or damaged goods and see what is happening before it leaves your doorsteps – reducing theft-related mistakes. 
  • Create strong relationships with all partners along the entire supply chain so that you can develop a better range of processes and procedures.
  • Check with employees about their reasons for leaving employment. Ensure that all company documents are appropriately signed by people responsible for handling them, place the right amount of cash in order trays before handing over to customers; make sure that every item purchased is accounted for on each invoice.
  • Ensure that no goods or products are left unattended, especially the valuable ones like jewelry, precious metals, or even electronics.
  • Businesses dealing in expirable products or items, such as pharmaceutical stores, need to create a systematic process for checking expiry dates since expired items cannot be consumed and are thrown away as waste, making them easy targets for theft.
  • Make use of a shrinkage analysis to determine where you are losing more money and then find ways to fix the problem. Remember that every business has to face different issues - what proves handy for one might not work for the other. Make sure you measure your shrinkage rates regularly to keep track of how your efforts are working.  
  • Ensure you do not violate any laws during your sale activities – avoid tax fraud by using proper documentation (like bills of sales, etc.) when transferring ownership; make sure that no false declaration was made at the time of registration or licensing, etc.


Inventory shrinkage occurs for various reasons, leading to a huge loss of business revenue and customer dissatisfaction due to the unavailability of products. The blog has highlighted different steps to curtail inventory shrinkage, and the most effective is implementing the best inventory management software. The tool can help minimize all mismanagement and fraudulent activities. 

If you want to test the tool before using it, you can select one of the top free and open source inventory management software. Other powerful tools that you can try include Orderhive, Odoo, PartKeeper, RightControl Lite, ABC Inventory, and many others. Still not sure? Just go through the Inventory Management Software Buyer’s Guide that includes detailed information about the tool and its purpose. You can consult it before planning to finalize a vendor. 

Chris Machetto
Chris Machetto

Chris Machetto is the Founder of Frenchy Digital, a mobile app and eCommerce development company that specializes in developing solutions for enterprises.

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