Shrinkage (Inventory) – Definition

Cite this article as:"Shrinkage (Inventory) – Definition," in The Business Professor, updated September 10, 2019, last accessed October 29, 2020,


Shrinkage Definition

Shrinkage is described as a reduction or loss of inventory due to theft of inventory, spoilage and other factors. The difference between the inventory that a company records on its balance sheet and the actual inventory available in the company is shrinkage. Factors that cause shrinkage include goods being damaged, administrative error, fraud and theft, loss of inventory, cashier error and others.

The inventory of a company plays a key role in its income, hence, shrinkage in inventory means loss of money. Shrinkage is always a major problem for retailers, it particularly affects the account of a company.

A Little More on What is Shrinkage

If the inventory recorded on a company’s balance sheet is worth $300, 000 and the actual inventory that a retailer can account for is $220,000, shrinkage has occurred. The value of shrinkage form this example is $80, 000 which is a huge loss for the company. To calculate shrinkage in a company, deduct the value of the inventory in its balance sheet from the value of its physical (actual) inventory. For many retailers, pegging shrinkage to a particular factor is a difficult thing to achieve because there are many factors that contribute to shrinkage such as theft, cashier;s error, administrative error, damage or loss of items and others.

The Disadvantages of Shrinkage

There are many disadvantages of shrinkage, the major ones are highlighted below:

  • Loss of profit: this is the major disadvantage of shrinkage. If not quickly addressed, it will not only cause loss of profits but also land a company to debt. Companies that experience shrinkage often find it hard to make revenue and profit.
  • Discrepancy between the book inventory and the physical inventory: this is another accounting problem that shrinkage cause retailers.
  • Shrinkage can cause an increase in the price of goods. This is because in a bid to recover from the effects of shrinkage, companies tend to hike the price of gods to recover losses.
  • Decline in customer base: Shrinkage can lead to a decline in a company;s custoner base in the sense that customers who will be forced to go for other options if the prices of goods are too expensive.

References for “Shrinkage › Investing › Financial Analysis

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