Image of a man looking at the warehouse inventory shrinkage levels using a tablet

Inventory Shrinkage – Causes, Consequences, and Tips

Inventory shrinkage is a common issue in businesses dealing with physical inventory. The consequences include financial losses, operational disruptions, and loss of competitiveness. But how does it happen, and how can it be prevented?

Table of Contents

  1. What is Inventory Shrinkage?
  2. How to Calculate Inventory Shrinkage?
  3. How to Calculate the Inventory Shrinkage Rate?
  4. Causes of Inventory Shrinkage
  5. Consequences of Inventory Shrinkage
  6. Tips for Minimising Inventory Shrinkage
  7. How to Report Inventory Shrinkage in Financial Statements?
  8. Enhancing Inventory Management with Brytebuild
  9. Key Takeaways
  10. FAQs

What is Inventory Shrinkage?

Inventory shrinkage occurs when the actual quantities in your inventory are smaller than what is recorded in your books or inventory management system. This discrepancy can arise from several factors, including administrative errors, damage, spoilage, theft, and supplier fraud.

According to a report by the British Retail Consortium (BRC), the average shrinkage rate in the UK retail sector was approximately 1.3% in 2022. No business that deals with physical inventory is immune to shrinkage.

Conducting stocktakes and comparing the results to your inventory records is the most reliable method of discovering inventory loss, as this provides concrete evidence of discrepancies.

How to Calculate Inventory Shrinkage?

To calculate the inventory shrinkage value, you can use the following formula:

Shrinkage Value = Inventory Value Record – Physical Inventory Value

For example, if £60,000 is marked as the company’s inventory value in their accounting records, and after an inventory count, the real physical inventory value is calculated to be £58,000, the shrinkage value is:

£60,000 – £58,000 = £2,000

Therefore, the company lost £2,000 worth of inventory during the period.

How to Calculate the Inventory Shrinkage Rate?

As inventory value can fluctuate, shrinkage value is not the most trustworthy metric for tracking shrinkage over time. To continuously measure shrinkage and use it as a KPI of your inventory management performance, start calculating the inventory shrinkage rate.

Inventory Shrinkage Rate = (Shrinkage Value / Inventory Value Record) x 100

Using the previous example, where the recorded inventory value was £60,000 and shrinkage was £2,000, the shrinkage rate would be:

£2,000 / £60,000 x 100 = 3.33%

This means that 3.33% of the inventory value was lost through shrinkage.

Causes of Inventory Shrinkage

Inventory shrinkage can be caused by many factors that usually work in combination. Here are some of the most common causes of shrinkage:


Damage to inventory items can occur during various stages of the supply chain, from handling in the warehouse to transportation. Physical damage often results in a reduction in actual inventory levels compared to what is recorded in the accounting books.


Perishable goods or products with expiration dates can suffer from spoilage. When these items go bad before being sold, it leads to a loss of inventory. This is particularly common in the food and pharmaceutical industries.

Production Errors

Mistakes in the production process may cause scrapped materials or defective products that need to be written off. This is often seen in manufacturing environments where quality control is crucial.

Employee Theft

Internal theft by employees is a significant contributor to inventory loss. According to the Centre for Retail Research, employee theft accounted for 33.7% of all retail shrinkage in the UK in 2023.


Shoplifting by external parties is an extremely common cause of shrinkage in retail environments. It occurs when customers steal products from the store. According to the British Retail Consortium, shoplifting cost UK retailers over £700 million in 2022.

Vendor Fraud

Vendor fraud occurs when suppliers manipulate orders or invoices, providing fewer items than what was agreed upon or charging higher prices. This leads to a discrepancy between the actual inventory and the recorded amount.

Inventory Miscounting

Errors in counting inventory during physical inventory counts or cycle counting can lead to inaccuracies in recorded inventory levels. These human errors can result from miscounts, omissions, or double-counting of items.

Administrative Errors

Administrative errors in inventory accounting, such as data entry mistakes, can create discrepancies between actual inventory and recorded amounts. These are often unintentional human errors but can have serious consequences.

Consequences of Inventory Shrinkage

Inventory shrinkage can lead to several serious consequences:

Financial Loss

One of the most immediate and direct consequences of shrinkage is financial loss. It reduces the value of a company’s assets and directly impacts your bottom line because the cost of the lost inventory is subtracted from revenue without any corresponding benefit from sales.


Shrinkage can lead to unexpected stockouts, where you run out of products to sell or materials to use in manufacturing. This can delay production schedules and disappoint customers, leading to lost sales.


To compensate for shrinkage, some businesses may overstock inventory as a buffer, tying up capital that could be used elsewhere. This also increases holding costs and the risk of inventory becoming obsolete.

Operational Disruptions

Frequent stockouts and overstock situations disrupt normal operations, leading to inefficiencies and increased costs in supply chain management, production stoppages due to material shortages, and the inability to fulfill orders on time.

Damage to Reputation

Constant late or incomplete deliveries can lead to customer dissatisfaction and loss of business. In today’s competitive market, maintaining a good reputation is crucial for customer retention.

Increased Costs

Maintaining excess inventory as a safeguard against shrinkage-related stockouts increases holding costs. Additionally, dealing with and analyzing inventory loss often requires additional labour hours.

Loss of Competitiveness

A company that consistently struggles with shrinkage may lose its competitive edge in pricing, availability, and customer service compared to more efficient competitors. Efficient inventory management is crucial for maintaining competitiveness in the market.

Tips for Minimising Inventory Shrinkage

Conduct Regular Inventory Audits

Regular inventory audits involve physically counting and verifying the actual amount of inventory on hand against what is recorded in your records. These audits help identify discrepancies and shrinkage issues promptly, enabling you to take corrective actions. Implementing a schedule for these audits, such as monthly or quarterly, ensures that you stay on top of inventory accuracy.

Using cycle counting methods, where you continuously count a portion of your inventory over time, can provide a more real-time view of inventory levels and reduce the need for massive annual audits. By regularly auditing your inventory, you can uncover issues early, address root causes, and prevent shrinkage from escalating.

Train Employees

Training should cover various aspects, including proper inventory handling to prevent damage, understanding production processes to avoid overproduction or errors, accurate data entry to maintain inventory records, and adherence to First Expired, First Out (FEFO) principles for perishable goods. Well-trained staff can drastically reduce human errors that contribute to inventory shrinkage.

Training programmes should be ongoing, with regular refreshers, and should also include security awareness to prevent internal theft. Engaging employees in the importance of inventory accuracy and making them aware of how their actions impact the bottom line can be motivating factors in minimising shrinkage.

Implement Security Measures

Implementing security measures is vital to prevent both internal and external theft. Internal theft, such as employee theft, can be deterred with security systems like surveillance cameras and access control measures. These not only act as deterrents but also provide evidence in case of suspicious activities.

For e-commerce and point of sale (POS) settings, secure payment processing and order verification processes also contribute to preventing inventory loss.

External theft, such as shoplifting, can be reduced with vigilant staff, proper store layout, and security personnel. It’s essential to regularly review and update security systems to stay ahead of potential threats and maintain a safe environment for your inventory.

Conduct Vendor Audits

Regular vendor audits are crucial to combat vendor fraud. These audits involve verifying that the products received match the purchase order, both in terms of quantity and quality. They also ensure that the agreed-upon pricing and terms are adhered to. Maintaining strong supplier relationships and transparent communication can help reduce the risk of fraud.

Implementing vendor scorecards and KPIs can help you evaluate supplier performance regularly. If a supplier consistently fails to meet expectations, it may be time to reassess the relationship and explore alternative sources to protect your inventory from vendor-related shrinkage.

Use Proper Stocktaking Procedures

Stocktaking procedures should include guidelines for conducting physical counts, reconciliation processes to address any discrepancies discovered during the count, and steps to handle damaged or spoiled inventory items. Double-checking counts and using barcode scanning systems can further improve accuracy and reduce human errors.

Establishing clear protocols for reporting and addressing discrepancies between physical counts and recorded inventory levels ensures that issues are promptly investigated and resolved. Developing standard operating procedures also plays a crucial role in training new employees and maintaining a consistent approach to inventory management throughout your organisation.

Implement Inventory Management Software

Inventory management software offers real-time tracking of inventory levels, automates inventory control tasks, and provides insights into inventory turnover. It streamlines the entire inventory management process, from creating purchase orders and receiving goods to tracking inventory movements and sales.

Barcode scanning capabilities make data entry more efficient and accurate, reducing the risk of errors that contribute to shrinkage. Inventory management software also offers detailed reporting and analytics, helping you identify trends and anomalies that may indicate potential shrinkage issues, allowing for proactive measures to be taken.

Overall, implementing such software increases efficiency, accuracy, and visibility in managing inventory, contributing to shrinkage prevention and minimisation efforts.

How to Report Inventory Shrinkage in Financial Statements?

Inventory shrinkage is recorded in financial statements as an expense, typically under the category of Cost of Goods Sold (COGS) or as a separate line item, depending on the accounting method used. Here’s how shrinkage is recorded in financial statements:

As a Component of COGS

Under the accrual accounting method, when shrinkage occurs, it is recognised as a reduction in the value of inventory. This reduction is treated as an expense and is included in the COGS section of the income statement. It directly impacts the calculation of gross profit.

Separate Line Item in Expenses

In some cases, businesses may choose to report inventory loss as a separate line item in their income statement under operating expenses. This approach provides a clearer breakdown of expenses and allows for easier tracking and analysis of shrinkage over time. The income statement might include a line item like “Inventory Shrinkage Expense” or “Inventory Losses.”

Specific Accounting Treatment

Shrinkage may be recorded using specific accounting treatments depending on the circumstances and accounting standards followed by the business. For example, if the loss results from a sudden and unexpected event, it may be treated differently than routine shrinkage. Businesses should adhere to generally accepted accounting principles (GAAP) or other relevant accounting standards in their region when recording inventory shrinkage.

It’s important to note that the method used to record inventory shrinkage in financial statements can vary between businesses and industries. The chosen method should align with accounting standards and accurately reflect the impact of shrinkage on the company’s financial performance. Additionally, maintaining accurate records and documentation of loss incidents is essential for transparency and compliance with accounting regulations.

Enhancing Inventory Management with Brytebuild

Brytebuild offers a comprehensive suite of inventory management tools designed to help businesses of all sizes minimise shrinkage and optimise their operations. Here’s how Brytebuild can support your inventory management efforts:

  • Real-Time Inventory Tracking: Brytebuild provides real-time updates on inventory levels, movements, and costs, ensuring that you always have an accurate view of your stock.
  • Barcode Scanning: Integrated barcode scanning capabilities streamline data entry, reduce errors, and enhance the accuracy of inventory records.
  • Detailed Reporting and Analytics: Access detailed reports and analytics to identify trends, track shrinkage rates, and uncover potential issues before they escalate.
  • Security Features: Implement robust security measures, including access controls and surveillance integration, to prevent both internal and external theft.
  • Vendor Management: Conduct vendor audits and track supplier performance to mitigate the risk of vendor fraud and ensure you receive what you’ve ordered.
  • User Training and Support: Brytebuild offers comprehensive training and support to ensure that your team can effectively use the system and maintain inventory accuracy.

Try Brytebuild Today

Experience the benefits of Brytebuild’s advanced inventory management features. Contact us for a demo or sign up for a free trial to see how we can help you minimise shrinkage and optimise your inventory processes.

Key Takeaways

  • Inventory Shrinkage: Occurs when the actual quantities in your inventory are smaller than what is recorded in your books or inventory management system.
  • Common Causes: Include damage, spoilage, production errors, employee theft, shoplifting, vendor fraud, inventory miscounting, and administrative errors.
  • Consequences: Financial loss, stockouts, overstocking, operational disruptions, damage to reputation, increased costs, and loss of competitiveness.
  • Prevention Tips: Conduct regular inventory audits, train employees, implement security measures, conduct vendor audits, use proper stocktaking procedures, and implement inventory management software.
  • Financial Reporting: Inventory shrinkage is typically reported as an expense in financial statements, either within the “Cost of Goods Sold” (COGS) section or as a separate line item under operating expenses.


What is inventory shrinkage?
Inventory shrinkage occurs when the actual quantities in your inventory are smaller than what is recorded in your books or inventory management system.

What common events could result in inventory shrinkage?
Common events that could result in inventory shrinkage include damage, spoilage, production errors, employee theft, shoplifting, vendor fraud, inventory miscounting, and administrative errors.

How to report inventory shrinkage in financial statements?
Inventory shrinkage is typically reported as an expense in financial statements, either within the “Cost of Goods Sold” (COGS) section or as a separate line item under operating expenses, depending on accounting practices.

How to calculate inventory shrinkage?
Inventory shrinkage can be calculated using the formula: Shrinkage Value = Inventory Value Record – Physical Inventory Value. To track shrinkage over time, you can calculate the Inventory Shrinkage Rate using the formula: Inventory Shrinkage Rate = (Shrinkage Value / Inventory Value Record) x 100.

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