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If you have taken your physical inventory count and come up short (again), it is time to get serious about changing this at your store. While shrinkage will never be eliminated in the retail environment it can, and must, be controlled. Most small, independent retailers who operate stores downtown or in strip centers should have shrinkage no more than one half to three quarters of a percent. 

One of the most important things you, as an owner, can do to reduce shrinkage is to let all your employees know that it is important to keep shrinkage down to an acceptable level. No one enjoys working hard all year and having their Income Statement show a small profit only to have that profit disappear after the physical inventory count has been taken and shrinkage recorded.

Shrinkage can occur at any point where merchandise and people come in contact. Studies have shown that 48% of all shrinkage is due to internal theft. Recordkeeping errors can also cause “paper” shrinkage. Even a store’s best customers are not immune to the temptation of taking something without paying for it.

You need to make sure that all inventory records and reports are accurate. If records are not accurate you really do not know if the problem is due to missing merchandise or to the office entering a transaction twice, or a salesperson not recording a markdown at point-of-sale. This means making sure that all procedures and forms are set up and properly used throughout the store. ALL employees need to be made aware of the importance of accurate record keeping, whether they are writing up a sale, receiving and marking merchandise or entering transactions into the computer.

No single shrinkage control program will work for every retailer since every situation is unique. The important point to remember is that you need to separately account for the amount lost through inventory shrinkage and then make shrinkage control a high priority with all employees doing their part to achieve the shrinkage goal. 

While it may seem a little extreme, I have talked with one retailer who told me he had set up a reward/penalty system. If shrinkage was below a set level all the employees received a bonus. However, if shrinkage was too high all employees had to actually PAY a penalty to the store. He told me that the first time they took a physical inventory count the employees had to pay. Since that time the store has been achieving their shrinkage goal. It does work.

Whatever way to attack this problem, do not delay. Get started now so your next physical inventory count will be at or below your goal.

A survey done by the National Retail Security Survey for 2006 reports that the breakdown of shrinkage causes are:

47%     employee theft
32%     shoplifting
14%     administrative error (paperwork errors in your office and store)
 4%     vendor fraud

Did you know that inventory shrinkage remains the single largest category of larceny in the United States, more than motor vehicle theft, bank robbery and household burglary combined?

If your fiscal year ended in December, January or February it is too late to do anything about last year’s shrinkage. However, everyone can take steps so shrinkage for the current year will be less.

Too many times retailers do not get the most value from the information available from the physical inventory count. They either do not know how to analyze the results or do not take the time to do so. Due to this they fail to make the changes in their operation that will help them to reduce future losses due to shrinkage. Of course, there are costs involved in instituting tighter internal controls. However, in most cases these costs are not significant and can provide other benefits for the company because a well-run and controlled business is a more profitable business.

Was your shrinkage as low as you expected, and wanted, it to be? If not, following is a procedure to help you determine the probable cause of shrinkage for each individual classification (you will need unit information in addition to retail data to do this):

1.  Calculate the average retail of inventory shrinkage.
     (retail shrinkage dollars divided shrinkage units)
2.  Calculate the average retail of merchandise sold for the past year.
     (sales dollars divided by units sold)
3.  Calculate the average retail of merchandise in ending inventory. 
     (retail dollars divided by units)
4.  Compare the average retail of inventory shrinkage to the averages of merchandise in inventory and sold. 

Using a spreadsheet makes the calculations easy and less time consuming.

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: misclassified merchandise (wrong class number used when entering receipts, sales, markdowns, transfers or 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 (add together and then average the two), the cause of shrinkage is most likely missing merchandise.

Review the data carefully. It can tell you a lot if you know what to look for.  Common causes of shrinkage are: misclassified merchandise, un-recorded transactions such as un-recorded markdowns, employee fraud and shoplifting. For example, did Long Sleeve Sport Shirts have a shortage while Long Sleeve Dress Shirts showed an overage? This could mean that a merchandise receipt was recorded using the wrong class number. In a multi-store company, if Mens Blazers is ‘short’ in Store 1 but ‘over’ in Store 2 the most likely cause was merchandise transfer that was not recorded. 

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. 

Let your employees know that any employee caught stealing from the company in any manner will be immediately terminated and a police report will be filed. Some situations are more conducive to theft than others. The opportunity to commit fraud is more convenient when people have access to financial accounts, when no one audits them, and when they think it is unlikely they will be caught or prosecuted or punished. Fraud is easier when companies have poor internal accounting controls and when they fail to follow them. Occasionally, fraud is so convenient that even honest people are seduced by the opportunity presented to them even though they had no intention of being dishonest. 

You must 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. For small independent retailers that provide good personal service, shrinkage should be no more than 0.50% to 0.75% of sales.  If your store is in a mall, the shrinkage is likely to be a little higher, perhaps as much as 1.25% of sales. If your shrinkage was more than this, you have a problem that you need to attend to now so the next physical inventory count will be much better!


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