Inventory Shrinkage: Definition & How to Prevent It

Allison Champion
6 min read
February 10, 2023
Modified: May 4, 2024

Updated May 04, 2024

Inventory shrinkage — whether it’s due to miscounts, damage, fraud, or external or internal theft — can cost a business both time and money. Brands should familiarize themselves with what inventory shrinkage is, how to track it, and how to prevent it.

What is inventory shrinkage?

Inventory shrinkage is an important inventory management KPI that measures the number of goods a brand should have (according to inventory management software) but cannot physically account for. What happens here is that a brand can’t sell a product that it does not actually have in the warehouse, which can lead to delayed orders and unsatisfied customers. Miscounts, damage, fraud, and external or internal theft can all lead to an inventory shrink .

Importance of inventory shrinkage in business

Every piece of inventory that’s on a brand’s book but can’t be physically found is considered phantom inventory and represents lost revenue. The inventory loss situation gets worse when that missing stock is purchased online or on a marketplace by a customer. While the storefront might be able to sell the product, the warehouse cannot fulfill that order, which can lead to some seriously unsatisfied customers.

A large amount of inventory shrinkage can also impact how lean a business can be with inventory levels. Having an accurate view of inventory items helps brands reorder at the right time to not have to pay to store excess products but avoid stockouts.

What causes inventory shrinkage?

Inventory shrinkage can be caused by employee theft, shoplifting, administrative error, supplier fraud, damage, and cashier error. According to SheerID , employee theft , and shoplifting account for more than 75% of inventory shrinkage, while administrative error and vendor fraud account for almost 20%.

Employees have direct access to all a brand’s products, and poor inventory count , warehouse management and security can result in employee theft. Employee theft can be a bigger concern for ecommerce businesses without a retail store — which limits shoplifting.

Impact of inventory shrinkage on business operations and profitability

Accounting for inventory shrinkage is critical for an ecommerce business. The most important impact of shrinkage is that lost products can’t be sold which directly results in lost revenue. The inventory to sales ratio is a key indicator of this. If a brand’s inventory reports don’t match sales records, someone needs to spend time reconciling accounting records.

How to calculate inventory shrinkage

Inventory shrinkage is calculated by first subtracting actual inventory from recorded inventory and then dividing it by recorded inventory. You can convert that into an inventory shrinkage percentage by multiplying the result by 100. Here’s the formula.

Inventory Shrinkage Rate = (Recorded Inventory – Actual Inventory) / Recorded Inventory

How to prevent inventory shrinkage

Although inventory shrinkage is a problem for all retailers, there are several ways to prevent the main causes of inventory shrinkage. There are many ways for traditional brick and mortar retailers to prevent shoplifting (think: security tags and cameras), but ecommerce brands should focus on preventing employee theft from warehouses and vendor fraud.

Tips for improving inventory accuracy and tracking

A key way to prevent inventory shrinkage is to improve inventory tracking and inventory accuracy. Counting inventory often — using software that counts inventory in real life rather than a manually updated Excel spreadsheet — can help identify shrinkage before it becomes a large problem. Doing this on a regular basis in a pattern can cut down on the time it takes. Also, doing regular inventory audits to find inventory discrepancies is important and can help improve inventory control.

Best practices for reducing theft and loss

On the employee theft side of things, conducting surprise inventory audits can prevent employees who are stealing from being prepared. Heightening security in warehouses or brick–and–mortar stores can also prevent employee theft and improve the accuracy of your physical inventory count. Brands can also educate employees on the impact of inventory shrinkage because they might not fully understand how small theft impacts the bottom line and, ultimately, their jobs. Using a 3PL that partners with fulfillment warehouses and has measures in place to prevent theft can also decrease inventory shrinkage.

When dealing with vendors, it’s important to verify orders with vendors and double – check on purchase orders. It’s also important to split responsibilities among employees so one person is not responsible for both recording and processing receipts.

4 Types of Inventory Shrinkage

Manufacturer Shrinkage

Manufacturer shrinkage refers to the loss of inventory that occurs during the manufacturing process. Miscounts in physical count or flaws in inventory records can lead to a mismatch between recorded inventory value and the actual stock available.

Vendor Shrinkage

Vendor shrinkage is the loss that occurs between a supplier and a buyer, often due to miscommunication or errors in handling goods. Loss prevention strategies should include thorough checks when goods are received, ensuring the quantities and conditions match the purchase orders.

Retail Shrinkage

Retail shrinkage typically results from shoplifting, employee theft, and administrative errors. Effective loss prevention techniques are crucial here, including physical counts to verify that the inventory records match the actual stock on the shelves. Regular training on proper inventory handling and the importance of accurate record-keeping can reduce human error, securing the inventory value.

Restaurant and Hospitality Shrinkage

This type of shrinkage is prevalent in environments where goods are quickly consumed or perishable like food and beverages. Errors in inventory records, waste, and theft can significantly impact the recorded inventory value. Conducting frequent inventory audits and maintaining stringent controls on inventory levels can help manage shrinkage in these high-paced settings.

Effects of Inventory Shrinkage

Profit Reduction

Inventory shrinkage directly impacts the bottom line by reducing the available inventory for sale. Without accurate physical counts, a business may record higher inventory than available, leading to a mismatch in profit calculations based on the inflated inventory value. This discrepancy can result in apparent profits that do not exist, harming the financial health of the company.

Rising Expenses

The hidden cost of shrinkage includes increased operational expenses. Businesses may find themselves purchasing additional inventory to compensate for unexplained shortages, which are often a result of inaccurate inventory records. Implementing effective loss prevention strategies and regular inventory audits can help identify the root causes of shrinkage, ultimately reducing these unnecessary expenses.

Escalation of Prices

To offset losses from shrinkage, businesses often escalate prices, which can affect customer satisfaction and competitive positioning. Regular inventory audits and accurate physical counts ensure that businesses can maintain more consistent pricing by accurately accounting for inventory and reducing losses due to shrinkage.

Benefits of preventing inventory shrinkage

Reducing inventory shrinkage has a direct impact on a brand’s bottom line because fewer products are going missing and can be sold. In addition, brands that reduce inventory shrinkage can run a leaner supply chain and reorder products in just enough time to prevent stockouts — without having to worry about products going missing.

Optimize your inventory management with Flowspace

Flowspace partners with ecommerce brands to optimize logistics, including ordering, processing, picking, packing, loading, shipping, and more. Flowspace’s OmniFlow Visibility Suite gives brands real-time inventory visibility and the ability to track inventory management KPIs like inventory shrinkage. But Flowspace’s platform goes beyond just tracking supply chain KPIs; Flowspace’s platform gives retailers actionable insights in order to improve and optimize their inventory KPIs.

The OmniFlow suite of tools provides visibility from fulfillment through delivery with platform-level transparency so brands can stay ahead of low inventory. The platform’s real-time insights and predictive analytics allow brands to forecast inventory needs and never be caught with out-of-stock products. Ensuring optimal inventory levels can improve customer satisfaction and build customer retention.

Flowspace’s inventory planning and forecasting software gives brands real-time insights and recommendations for inventory optimization. Having access to real-time data allows brands to perform those all-important surprise audits on physical inventory without alerting employees. Actionable inventory data can also help brands make informed safety stock decisions to avoid an out-of-stock situation. Investing in inventory planning software makes facility management and inventory tracking much easier while ensuring customer service level expectations are met.

Get in touch with Flowspace today to learn more about our inventory management software.


Boehmer, Madeline. 2016. “25 Jaw Dropping Statistics about Employee Fraud in 2015.” SheerID. June 2, 2016.

Written By:

flowspace author Allison Champion

Allison Champion

Allison Champion leads marketing communication at Flowspace, where she works to develop content that addresses the unique challenges facing modern brands in omnichannel eCommerce. She has more than a decade of experience in content development and marketing.

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