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Many retailers have just concluded taking their physical inventory count and comparing it to their book inventory. Was your shrinkage as low as you expected it to be? If not, following is a procedure to help you determine the probable cause of shrinkage for each individual classification:

  1. Calculate the average retail of inventory shrinkage.

  2. Calculate the average retail of merchandise sold for the past year.

  3. Calculate the average retail of merchandise in ending inventory.

  4. Compare the average retail of inventory shrinkage to the averages of merchandise in inventory and sold.

If the average unit retail of inventory shrinkage for a class is considerably higher than the average unit retail of ending inventory and units sold, the probable cause of shrinkage is due to unrecorded markdowns and missing merchandise. This is the most common source of discrepancy we see.

If the average unit retail of inventory shrinkage is considerably lower than the average unit retail of ending inventory and units sold, then a partial cause of shrinkage is due to one or both of the following reasons: mis-classed merchandise (wrong class number used when entering receipts, sales, markdowns, transfers, physical counts) or employee fraud.

If the average unit retail of inventory shrinkage is very close to the average unit retail of ending inventory and sold merchandise, the cause of shrinkage is most likely missing merchandise.

** Note: if you would like an Excel spreadsheet template to use to calculate these numbers, just send an us an email and we will email it back to you.

There are numerous things, other than missing merchandise, unrecorded markdowns or employee fraud that can cause shrinkage. If the physical count is poorly done and some merchandise is not counted, it will show up as missing merchandise, even though it is actually not missing. Or if some merchandise is counted using the wrong class number or incorrect price the physical count will be distorted.

Many times, paperwork errors show up as overage when the physical count is compared to the book inventory. Overage is bad because it hides or distorts actual shrinkage. It also distorts Gross Profit for a classification, making it appear higher than it actually is.

If you want to reduce shrinkage and increase the accuracy of your inventory records, the first step is to make it a high priority in your store. Employees must be educated in what to look for so they can detect shoplifters. Use physical deterrents to discourage shoplifters, such as keeping small expensive items behind the counter and eliminating any blind spots. You must communicate to your employees the importance of paying attention to the details and making sure that all paperwork is completed in an accurate and timely manner.

The next step is to set up procedures that include good internal controls. Shortages can and will occur at every point where merchandise changes hands or paperwork is created or processed, from the time it comes in the back door until it is sold and leaves the store. Every step of this process involves both people and the forms on which the transactions are recorded. The receiving/marking person records the receipt of merchandise, checks it and attaches the price tags. This person also handles merchandise that is returned to the vendor. The sales staff handles sheet (or bulk) markdowns and records sales, including any POS markdowns. And of course the office is responsible for accurately recording in the books all the information from all the forms that come into the office. The process can break down at any of these points.

Shrinkage can be controlled. Management must give it a high priority, employees must be trained, and internal controls must be put in place and monitored.

If your Net Profit is 5% of sales, it takes an additional $20 of sales to make up for each $1 of shrinkage. If shrinkage is $1,000 it will take an additional $20,000 in sales. It is just good business sense to initiate action to reduce your shrinkage figure as much as possible.

If you have a shrinkage problem or want to set up systems and procedures to avoid a shrinkage problem, give us a call. We can help. Or, if you want to handle the research yourself, order our “Internal Control Manual”. It was written specifically for the independent retailer. Click here for more information.


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Internal Controls
The Retail Management Advisors
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Allen, TX 75002


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