Understanding how to calculate shrinkage in retail is a fundamental but critical concept within the loss prevention/asset protection profession and throughout the retail industry. While it may surface in many different forms, ultimately retail shrink results in lost profits and can have a dramatic impact on the success of the retail enterprise.
The term “retail shrink” or “retail shrinkage” refers to the difference between the amount of merchandise (or inventory) that the retail company owns on its books, and the results of a physical count of the merchandise. The terms are interchangeable and carry the same meaning. Simply stated, it represents the difference between the optimal sales income that could be realized for all of the products that our company has purchased and the actual income that is realized after all of the different forms of loss have been accounted for.
As a starting point, understanding how to calculate shrinkage in retail begins with this basic formula:
Retail shrink can come in many forms and impact a business in different ways. Traditionally, the primary causes of retail shrink include operational errors, internal issues, and external losses. However, there are many different causes that may result in retail shrink and lost profitability.
- Operational errors can involve paperwork issues and other operational missteps. These incidents typically occur when processing a transaction, receiving merchandise, shipping merchandise, or taking inventory.
- External losses can involve theft by customers (primarily shoplifting), issues involving vendors, or other incidents that pertain to those not working for the company.
- Internal losses are the result of incidents that involve store associates and other company employees who take advantage of opportunities to steal from the company.
In addition to theft issues, damage, waste and spoilage are among the concerns that can directly contribute to a company’s losses.
When merchandise is stolen or otherwise unaccounted for, it not only impacts the company as a result of the missing product, but also skews our inventories in other ways. The impact goes beyond current sales; it also affects product replenishment and future sales as well. This can have a significant influence on the bottom line and even on the overall health of the company. Every year shrink issues cost retail businesses tens of billions of dollars. This is a real and growing problem that affects all of us in a variety of ways.
While certainly measured in terms of total dollars lost, retail shrinkage is most often expressed in terms of a percentage to company sales. This concept is important in understanding the interrelationship between loss prevention and other areas of the business.
For example, let’s say that a store that did $1 million in sales for the year conducted an inventory and discovered that $20,000 was lost to retail shrink. This would result in a retail shrink percentage of 2 percent:
$20,000 Losses / $1,000,000 Total Sales = 2% Retail Shrink
Understanding this concept, we can see that by improving our company sales, we will as a result impact our shrinkage numbers. Using our example above, let’s say that we had $20,000 lost to retail shrink, but we improved our performance to $2 million in sales:
$20,000 Losses / $2,000,000 Total Sales = 1% Retail Shrink
Although we maintained the same shrink dollars, our retail shrink percentage was dramatically improved by increasing our sales performance. While our ultimate goal is to reduce our retail shrink dollars as well as improving our sales performance, this example illustrates the importance that store sales performance carries in maintaining, enhancing or impairing our shrink results. Sales drive our overall performance, just as they affect every other aspect of the business.
Understanding how to calculate shrinkage in retail is important. However, understanding why it is important to control these results and how we can impact company profitability by both improving sales and controlling retail shrinkage is a key aspect of retail success.
This is a much more complicated problem than simply accounting for the theft of merchandise and the direct loss of profits. Managing shrink is a critical aspect of inventory control, which involves the management of the supply, accessibility, storage, and delivery of the company’s goods. As a result, shrink management strategies require a multifaceted approach in order to successfully manage the process. This is an important concept for every retail manager to learn and understand and will have a direct impact on company — and individual – performance.
This post was originally published in 2016 and was updated in March 2022.