Kevin Ian Schmidt

Inventory Shrink can be a Hidden Cost

What is inventory shrink? Inventory shrink is a reduction in physical inventory caused primarily by shoplifting, employee theft, administrative/operational errors, and vendor fraud.

Using the inventory shrinkage formula, you can find out your inventory shrinkage rate.  

Here are the steps you would need to take:

  1. Find out the book value of your inventory. This is the value of your inventory according to your balance sheet. Typically, this would be calculated at the end of each month, or perhaps each quarter, and is the difference between your previous inventory totals and the quantity of your goods sold. For example, if you previously had $30,000 in inventory, but you bought $2,000 and sold $10,000 of inventory, then your balance sheet should indicate that your inventory is worth $22,000.
  2. Then, calculate the actual value of your inventory. Do a physical check of your inventory in stock and log the quantities on the shelf and calculate the value by multiplying the inventory quantities by the purchase costs.

Using these two values, you can calculate your inventory shrinkage rate with the formula below.

(Book value of inventory – Actual value of inventory)/Book value of inventory x 100 = inventory shrink %

The Need For Effective Inventory Shrinkage Prevention

The key to preventing inventory shrinkage is to acknowledge it is happening and take quick action to put an end to it. Understanding the causes of inventory shrinkage is the first step towards reducing it.

Inventory Shrinkage Control Recommendations

Cameras: Invest in security cameras and place them around your stock locations. In addition, put up warning signs of theft around your stock. By monitoring your inventory carefully, you can spot any suspicious behavior and take action when necessary. Cameras and warning signs serve as a deterrence for thieves who do not want to risk the chance of getting caught.

Reduce Temptation: To prevent theft in retail stores, higher-value items should be stored in secure areas that require a store employee’s authorization to access them. For example, some wine and spirit stores stock their pricier alcohol at the cashier area. For a customer to purchase or look at them, they must ask a store employee to assist them. This makes it harder for shoplifters to target your more lucrative items to steal.

Eliminate Fraudulent Sales Transactions: Sales fraud can take on many forms: from giving excess discounts and pocketing the difference to falsifying vendor bills. Here are some common examples of how this happens:

  • An employee deliberately inflates the quantity of the goods sold with an intention to steal the excess inventory.
  • Creating fake customer accounts where products are sold to an undisclosed location for the employee to sell on their own while the bills are set to due for collection but are never collected.
  • The setting up of fake vendor accounts to pay for bills or products that will never reach your warehouse while the employee pockets the money.
  • Creating a vendor kickback scheme where your company overpays a vendor for inventory goods, only to have the insider in your company get a cut of the overpayment as an incentive for continuing the scam.

There are several ways to combat this issue.

  • First, split up responsibilities for important tasks in your business workflow. That way, any key process must pass through a few individuals. For example, assign one individual the responsibility to approve the sale and another to fulfill the order from inventory.  This will lower the chance of any fraud from occurring with the process becoming more transparent for the entire organization.
  • Secondly, you can set internal controls in place where only a select group of people can create or view certain transactions. With restricted access, you can be assured that employees are not given the freedom and access to manipulate and cheat your system.
  • Thirdly, ensure that you conduct spontaneous and regular audits to inspect your internal business operations. Look into any suspiciously close relationship between your team and your vendors or customers. Follow up on any dead accounts or uncompleted transactions to verify if the order and customer are legitimate.

Track Inventory: Having an inventory tracking system allows you to be aware of all your inventory at all times. From your raw materials to the final sales process, it is vital for you to know where your inventory is at all times. By keeping track where each stock is, you can examine if your goods are genuinely missing or due to some other reasons. You can track your stock on an individual or a lot tracking level, depending on your business requirements.

Stop Shipper & Vender Fraud: Fulfillment can often be a difficult place to detect scams, due to the hectic activity of a warehouse shipping and receiving items. To avoid fraud, check your shipping slips and shipments carefully for products that claimed to be “defective.” For these goods, ensure that you have an inspection process in place to verify those claims before disposing of them. Assign your inspections to someone not on the shipping team to prevent a conflict of interest. Also, it is good to keep a record of these inspection reports to analyze any strange pattern or trends that are worth digging further.

Vendor fraud only accounts for a small percentage of actual losses, however if it continues to remain undetected the losses can be substantial.

There are four common types of vendor fraud.

  1. The first instance of vendor fraud deals with the vendor not delivering the correct amount of inventory on the shipping invoice. This method can be conducted in numerous ways. Small amounts of inventory can easily be removed from the packaging or boxes and remain unnoticed. Another method is fewer boxes are delivered than specified on the invoice. For example, the business orders ten boxes of widgets and only receives eight boxes, this can be vendor fraud. Another example is when the items delivered are smaller than the items ordered. For instance, if ten boxes of ten-ounce widgets are ordered and ten boxes of nine-ounce widgets are received, this can be vendor fraud.
      • To protect oneself from this type of vendor fraud, several measures can be taken. The first is to count all inventory once it is delivered and verify the amounts with the packing invoice. Do this by opening all boxes and verifying the original packaging seal is still intact and counting every piece of inventory. If time is a factor, randomly check the deliveries and do not check the boxes in the same manner. If random checks are more suitable, examine some boxes through the tops and the other through the bottoms. Also read the labels of the merchandise to confirm the actual size and note any discrepancies. These methods will deter this form of vendor fraud.
  2.  A second style of vendor fraud deals with the delivery person removing merchandise from the recipient once the delivery is completed. In this scenario, the delivery person waits for the inventory to be counted and then removes the merchandise from the store. To prevent this type of vendor fraud, the delivery person must be carefully watched while inside the store or stockroom. Also watch what the delivery person takes in and out of the store. The best suggestion is to have deliveries made to an area where the delivery person does not enter the store.
  3. A third type of vendor fraud deals with the delivery person directly stealing from the stockroom or the store. Swapping is a common technique in which the delivery person exchanges out of date products with new products. In actuality, the delivery person swaps good merchandise and replaces it with bad or outdated merchandise. To prevent this method, have employees separate the products that need to be exchanged before the delivery person arrives.
  4. A fourth way vendors steal is directly taking cash from the store. This can occur if payment for the delivery is done on site rather than billed later. A delivery person may alter an invoice by adding inventory or changing the final price resulting in an over payment. The delivery person pockets the over-payment. This method of fraud can be prevented by keeping the original invoice and by paying with a check.

Vendor Inventory Shrinkage Prevention Techniques

  • Separate sheets for store credits and invoices.
  • Do not accept a delivery without a packing slip.
  • Do not accept a packing slip without a delivery.
  • Verify invoice information is correct.
  • Never initial an invoice, a complete signature is best.
  • Create a log of all deliveries and have the delivery person sign it.
  • Do not accept verbal deals or agreements.
  • Do not allow the delivery person to distract you.
  • Do not pay cash for the delivery.
  • Never leave a store stamp in the open.
  • Do not allow multiple deliveries.
  • Schedule deliveries at a convenient time for you, never during busy hours.
  • Always complete your delivery check on the spot. Do not leave and return.
  • Carry out your empty boxes or garbage. Do not allow the vendor to do this.
  • Vendors should not mill around the store.
  • Only allow full time employees to accept deliveries.
  • Credits are to be dealt with first before the new delivery is brought into the store.
  • Never allow vendors to deliver after the shipper goes home.
  • Do not allow the vendor to carry merchandise to the sales area until entire delivery has been checked.
  • Do not accept samples unless they are listed on the shipping invoice.

When practiced, these techniques are very useful in hindering vendor fraud. Vendor fraud can be costly if the problem continues to go unnoticed.

Invest in an Inventory Management System: Wherever human beings are doing the counting, organizing and recording, errors are sure to happen. Choose software that:

  • Organizes product and vendor information
  • Integrates with your POS system so that inventory data is automatically updated after every transaction
  • Generates accurate purchase orders

Improve Pre-employment screening: The reality of retail is that employee turnover is high and company loyalty usually low. In addition, employees have less supervision and easy access to your valuables. Do your due diligence in hiring people with no history of dishonesty, including nationwide criminal background checks and verification that resumes are complete and truthful.

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