Inventory shrinkage is a major growing problem, costing businesses billions of dollars annually. It can be especially devastating for retailers, who often operate on tight margins, as even a small amount of shrinkage can significantly impact profits. In this article, we will discuss what inventory shrinkage is, how to reduce it, and which insurance policies can help you financially recover from theft so you can focus on running your business.
What is Shrinkage?
Shrinkage is the loss of physical inventory caused by a variety of factors, such as employee theft, shoplifting, administrative and operational error, and damaged or expired goods. It is the difference between your actual inventory and the amount your records say you should have. For example, a retailer with $1 million in recorded inventory may find they only have $750,000 in actual inventory after a physical count. This indicates the retailer has experienced $250,000 in shrinkage. According to the National Retail Federation (NRF), inventory shrinkage costs the retail industry an estimated $94.5 billion in 2021. However, the good news is you can reduce inventory shrinkage by putting a few simple processes in place.
6 Ways to Reduce Inventory Shrinkage
While it is impossible to eliminate inventory shrinkage entirely, there are several steps businesses can take to reduce it.
1. Train Your Employees
Employee theft is a major cause of inventory shrinkage, accounting for 42% of all losses. You can significantly reduce inventory shrinkage and protect your profits by training your employees on proper inventory management procedures, creating a culture of honesty and accountability, and theft prevention techniques.
2. Conduct Periodic Inventory Check
Periodic inventory checks are essential for preventing shrinkage because they allow you to identify potential losses and address discrepancies before they become too costly. A good rule of thumb is to conduct a full inventory check at least once a quarter and more frequently for high-value items.
3. Use Technology to Prevent Shrinkage
A variety of technologies are available to help businesses prevent theft and loss, including:
- Security tags -These tags deter theft by triggering alarms if the product is removed from the store without being paid for.
- RFID tags – Radio frequency identification tags track the movement of products throughout your warehouse, store, or supply chain and identify stolen products.
- SKU and barcodes – Stock keeping units (SKUs) and barcodes help automate inventory management and track the movement of products within the warehouse or store.
4. Implement Inventory Automation
Automated inventory management software helps businesses track their inventory levels in real-time and identify potential theft or losses more quickly. Additionally, this type of software can help to reduce manual labor, human error, and make it easier to identify missing items.
5. Set Up a Loss Prevention Plan
A loss prevention plan is a comprehensive document that outlines the steps your business will take to prevent theft and reduce shrinkage. It should include specific security procedures, inventory management, employee training, and so forth. It’s important to communicate this plan to all employees and ensure they understand their role in preventing theft and reducing shrinkage. As your business grows or changes, your loss prevention plan should also be updated to reflect those changes.
6. Optimize Your Warehouse and Store Security
One of the most effective ways to prevent inventory shrinkage is to improve security in your warehouse and store. CCTV cameras can help deter theft and protect your inventory, but there are other important security measures to consider, such as:
- Access control systems – These systems can restrict who has access to your warehouse and store and when they can enter and exit.
- Security guards – Security guards can provide a visible presence and deter theft, especially during off-hours.
- Intrusion detection systems – These systems can detect unauthorized entry into your warehouse or store and alert you of a break-in.
- Motion sensor lighting – Well-lit areas make it more difficult for thieves to operate undetected.
How to Calculate Inventory Shrinkage
Retail shrinkage is the discrepancy between recorded inventory and actual inventory. To calculate shrinkage, we use the following formula:
| Shrinkage = Recorded inventory – Actual inventory |
To better understand how much money a retailer loses to shrinkage, we can calculate the shrinkage rate as a percentage of total sales. A higher shrinkage rate means that the retailer is losing more money to shrinkage. The shrinkage rate is calculated using the following formula:
| Shrinkage Rate = (Shrinkage amount / Total Sales) x 100 |
So, what is an acceptable inventory shrinkage rate? As stated before, the retail industry’s average shrink rate was 1.44% in 2021 which resulted in over $94 billion lost. In other words, an acceptable inventory shrinkage rate should be as small as possible.
What Type of Business Insurance Covers Theft?
In addition to improving your security and taking steps to prevent theft and reduce shrinkage, buying the right business insurance is key. However, it’s important to note that these insurance policies do not cover shrinkage since it is a normal part of doing business, and it is difficult to identify the source of the loss.
1. Commercial Crime Insurance
Also known as business crime insurance or fidelity insurance, protects businesses from financial losses caused by criminal acts such as theft, embezzlement, forgery, fraud, and cybercrime. It can cover cash, assets, merchandise, or other business property losses. This type of policy can be purchased as a standalone policy or added as part of a business owner’s policy (BOP).
2. Inland Marine Insurance
Inland marine insurance reimburses the cost related to equipment loss, theft, or damage while it is in transit or temporarily stored off-premises. It includes coverage for a business’s inventory, equipment, furniture, and documents. While standard business policies offer coverage up to $10,000, inland marine insurance significantly widens the scope of protection, providing more comprehensive coverage.
3. Commercial Property Insurance
Commercial property insurance covers damage or loss of your business property, including your building, inventory, and equipment. It typically covers theft, such as burglary, robbery, shoplifting, and employee theft.
Is Looting Covered by Business Insurance?
Looting is typically covered by commercial property insurance as it provides coverage for your building and all its content against vandalism, theft, fire, and explosions. However, it’s important to note that specific coverage varies from policy to policy. For example, some business insurance policies may have exclusions for looting that occurs during civil unrest or natural disasters. Be sure to carefully review your policy to understand what types of losses are covered and what exclusions may apply.
Get a Quote from AIS Insurance
Our dedicated commercial insurance team can help you compare insurance options, limits, and deductibles. We make it a priority to understand your business. Speak with one of our Commercial Insurance Specialists today at (855) 919-4247 for a quick and easy free quote.
The information in this article is obtained from various sources and offered for educational purposes only. Furthermore, it should not replace the advice of a qualified professional. The definitions, terms, and coverage in a given policy may differ from those suggested here. No warranty or appropriateness for a specific purpose is expressed or implied.
