Inventory shrinkage is the excess amount of inventory listed in the accounting records, but which no longer exists in the actual inventory. Excessive shrinkage levels can indicate problems with inventory theft, damage, miscounting, incorrect units of measure, evaporation, or similar issues. It is also possible that shrinkage can be caused by supplier fraud, where a supplier bills a company for a certain quantity of goods shipped, but does not actually ship all of the goods. The recipient therefore records the invoice for the full cost of the goods, but records fewer units in stock; the difference is shrinkage.
To measure the amount of inventory shrinkage, conduct a physical count of the inventory and calculate its cost, and then subtract this cost from the cost listed in the accounting records. Divide the difference by the amount in the accounting records to arrive at the inventory shrinkage percentage.
For example, ABC International has $1,000,000 of inventory listed in its accounting records. It conducts a physical inventory count, and calculates that the actual amount on hand is $950,000. The amount of inventory shrinkage is therefore $50,000 ($1,000,000 book cost - $950,000 actual cost). The inventory shrinkage percentage is 5% ($50,000 shrinkage / $1,000,000 book cost).
There are many techniques available for preventing inventory shrinkage, including:
Fencing off and locking the warehouse
Preventing anyone except warehouse staff from entering the warehouse
Instituting bin-level tracking of inventory items
Assigning personal responsibility for inventory accuracy
Improving the accuracy of bill of materials records
Installing an ongoing cycle counting process
Tightly controlling the results of the physical count process, and how adjustments are incorporated into the inventory records
Counting all items when they arrive at the receiving dock
Counting all finished goods when they are shipped from the company