Shrinkage: Definition, causes, and business impact

If you ever wonder why your inventory numbers don’t match what’s on the shelf? 

You’re not alone, and that silent gap could be costing your business more than you think.

In this blog, we explain what shrinkage really means, why it happens, and how it quietly affects your bottom line.

Whether you’re in retail, warehousing, or accounting, understanding shrinkage is key to protecting profits and streamlining operations.

What is shrinkage?

Shrinkage is when your business loses money or products without actually selling anything.

Suppose you run a store. On paper, your system says you have 100 items in stock. But when you count them on the shelf, there are only 95. Where did those 5 items go? That missing piece is shrinkage.

”Shrinkage refers to the loss of inventory or cash due to theft, damage, errors, or fraud, creating a gap between what your records say you have and what’s there.”

What are the common types of shrinkage?

At its core, shrinkage takes three main forms:

Physical inventory loss:

It occurs when products vanish through theft or unrecorded disposals. Do you know when this is most likely to happen?

• After peak hours, when staff are rushed.
• During shift changes, when accountability fades.
• When inventory is moved, increasing risk exposure.
• During system outages, when manual tracking replaces automation.

Loss of value.

So the products are not stolen, but it occurs when goods are damaged, expired, or otherwise unsellable. For example:

• Damaged goods. Products with dents, crushed boxes, or cosmetic flaws.
• Expired items. Food or goods past their sell-by date.
• Out-of-season stock. Halloween costumes in November or Christmas decor in February.
• Open packaging. Items with broken seals or opened boxes.
• Internal consumption. Employees consuming chocolates and juices for example.
• Obsolete products. Outdated items that no longer fit current trends.

Misplacement or administrative errors.

Products are physically there but not where they’re supposed to be, for example, on the wrong shelf or in the wrong warehouse.

What causes shrinkage in business?

• Stolen items.
• Broken or spoilt goods.
• Inventory mistakes.
• Supplier issues.
• Poor stock handling.
• Check out errors.
• Fake or abused returns.
• Unknown losses.

Stolen items:

Stealing can be external, with customers shoplifting, or internal, when employees steal items without permission. Both forms of stealing can easily undermine inventory accuracy and overall business profitability. Stealing by vendors from external sources such as suppliers, contractors, and delivery staff can undermine your bottom line silently through:

• Short shipments (shipping less than invoiced).
• Fake or inflated invoices.
• Swapping out genuine products for lower-grade ones.
• Stealing directly from loading docks or storage areas.

These losses are rarely caught right away, and because they’re buried in the supply chain, they often get written off as simple shrinkage, not theft.

Broken or spoilt goods:

Damage to inventory can occur at any stage. From storage to transportation or even display. Items may break, spoil, or reach expiration before they can be sold, resulting in lost revenue and reduced stock availability.

Inventory mistakes:

Inaccurate tracking and documentation, such as misreporting quantities during scanning, can lead to discrepancies. For instance, receiving 20 units but recording only 18 can create inventory imbalances, affecting stock levels and operational efficiency.

Supplier issues:

Discrepancies between what was paid for and what is delivered can occur due to overcharging or fraudulent supplier invoicing. This often results in receiving fewer items than expected or being charged inaccurately, impacting inventory accuracy and financials.

Poor stock handling:

Inventory losses can arise from physical damage during handling or transportation, or spoilage due to expiration dates. These factors contribute to waste and reduced stock availability, negatively affecting profitability.

Checkout errors:

Inefficient inventory management practices, such as poor stock rotation or inadequate merchandising strategies, can lead to operational inefficiencies and shrinkage, affecting the bottom line. Mistakes made during checkout, whether intentional or accidental, such as incorrect pricing or discount adjustments, can result in revenue loss and erode profit margins, ultimately impacting sales performance.

Fake or abused returns:

Return fraud occurs when customers exploit return policies by attempting to return stolen, damaged, or even used items for a refund. This can also include returning items purchased fraudulently, such as using counterfeit receipts or stolen credit cards, resulting in financial losses and inventory discrepancies.

Unknown loss:

Unattributed loss refers to inventory shrinkage or discrepancies that cannot be directly traced to a specific cause, such as theft, damage, or administrative errors. It often results from a combination of factors like inefficiencies in stock management, poor tracking systems, or unnoticed operational issues, making it difficult to pinpoint the exact source of the loss.

Here are a few examples:

• Overstock from misforecasting. Buying too much due to bad sales predictions.
• Product samples or giveaways. Promotional items taken but not tracked.
• In-transit errors. Products lost or damaged during shipping.
• Untracked waste. Discarded or wasted materials not recorded as loss.
• Hidden damage in bulk stock. Damaged items unnoticed until unboxed.
• Employee theft of small items. Office supplies, snacks, or tools taken without notice.
• Unscanned or forgotten items. Products missed during inventory scans or audits.

Where does shrinkage happen?

Shrinkage may be at any phase of the retail process involving inventory or cash and thus must be watched at every phase.

Inventory losses can stem from receiving errors—such as miscounts or damaged goods—or from theft and disappearance during storage or display. 

Mistakes at the cash register, or even intentional theft, can also contribute to shrinkage.

Returns and inventory audits are also vulnerable points where discrepancies can arise due to inaccurate recording or fraudulent returns.

Inventory management challenges can occur at various supply chain stages and across multiple environments.

On store floors, in stockrooms, and during transit or delivery, the risk of discrepancies is high due to handling errors, theft, and misreporting.

How does shrinkage impact the business?

• Lower profit margins.
• Higher operating cost.
• Risk of price hikes.
• Inventory discrepancies.
• Stockouts and dissatisfaction.

Lower profit margins:

There’s no second opinion regarding shrinkage; it’s immediately clear that a cost has been incurred on either stolen or damaged inventory. In other words, it’s a loss.

Now the company has to also pay for unsold inventory. This can result in decreased profit margins.

Higher operating costs:

Businesses may need to hire more security guards or personnel to monitor shrinkage and inventory. This would mean more staff training and scheduled inventory audits, which would result in huge operating costs.

Risk of price hikes:

When business giants face contraction, they need to recover losses, and the sole way to do that is by raising prices. This contributes to inflation and consumer loss. Inventory lost or damaged is no longer available to sell, so the company gives up possible earnings on such goods.

Inventory discrepancies:

Shrinkage leads to a mismatch between recorded inventory and actual inventory, which can disrupt supply chains and make it difficult to meet customer demand. 

Stock-outs and Dissatisfaction:

If shrinkage is significant, it can lead to stock-outs, causing inconvenience and dissatisfaction for customers who can’t find the products they want. 

How to prevent shrinkage in business:

Shrinkage isn’t just missing inventory. It’s your business bleeding from places you’re not looking:

It’s not a product problem; it’s a systems, process, and people problem.

If you’re losing inventory, you’re not just losing products; you’re losing profit, control, and trust across your value chain.

Fixing it isn’t about locking things up tighter. It’s about building a business that leaves no room for loss from procurement to point of sale.

Here’s how:

1. Strengthen access control:

Limit who can access, handle, move, or account for inventory at every stage whether in warehouses, stores, or transit by strengthening access control measures like keycards, biometrics, or audit trails.

2. Implement real-time inventory tracking:

Track products as they move through the chain using RFID, barcode scanning, or AI-powered surveillance. This reduces human error and flags anomalies instantly.

3. Audit routinely, not randomly:

Conduct regular and scheduled audits at all points—from suppliers to store shelves. Compare physical counts to records and look for patterns in discrepancies.

4. Automate where possible:

Automation reduces manual errors. From automated stock checks to smart shelving, the fewer touchpoints, the lower the risk of shrinkage.

5. Vet and monitor suppliers:

Shrinkage can begin before inventory even reaches you. Work with reputable suppliers and conduct background checks. Build transparency into supplier relationships.

6. Train staff on loss prevention:

Educate employees on how shrinkage happens—and how to spot it. Encourage reporting of suspicious behavior and reward integrity.

7. Invest in smart surveillance:

Cameras are no longer passive. AI-powered surveillance can detect unusual behavior in real time and alert managers before loss occurs. 

Let us look at how surveillance can help businesses fight shrinkage.

How AI surveillance can help businesses fight shrinkage:

Shrinkage is what you should’ve had but don’t. And knowing where it goes is the first step to keeping your business secure and profitable.

Shrinkage doesn’t just happen at the checkout. It creeps in throughout the entire supply chain. From the moment inventory is received to when it hits the shelves.

That’s where smart surveillance steps in:

At the warehouse:

Cameras at receiving docks can capture every delivery. With timestamped footage, businesses can verify if items were short-shipped, damaged, or mishandled. Vendor fraud becomes traceable, and delivery disputes are easier to resolve.

During transit:

Whether it’s a supplier truck or an internal transfer, surveillance in and around loading bays ensures that nothing disappears in transit. Combined with GPS and delivery logs, it builds a full accountability trail.

In specialized stockrooms:

Like those storing food, pharmaceuticals, or beauty products. Cameras support strict oversight, helping spot mishandling, spoilage risks, or expired stock before it turns into a loss.

On the sales floor:

Retail shelves and storage rooms in shopping centers are hotspots for both internal errors and external theft. AI-powered surveillance systems can detect:

• Suspicious behavior.
• Shelf-sweeping attempts.
• Stock manipulation or concealment.

These alerts aren’t just recorded, they can be sent in real time.

Remote video monitoring:

Remote video monitoring becomes even more effective when linked to a third-party surveillance service. These teams can:

• Review alerts instantly.
• Verify suspicious activity.
• Dispatch help or notify in-house staff immediately.

No more waiting until after inventory counts to realize what’s missing. The system acts as it happens.

Suggested good read:

• Why retail theft never goes away.
• How to Stop Shoplifting with this Innovative Retail Anti-Theft Solution.

By combining video monitoring with innovative inventory practices, businesses gain visibility across all touchpoints, helping them reduce shrinkage, flag vendor fraud, and streamline operations from receiving to final sale.

Conclusion:

Shrinkage is not just products going missing. It’s an indication of inefficiencies that impact your business. It quietly leaches profit from your business through theft, damage, or administrative mistakes.

Knowing why and where shrinkage happens is the key to keeping inventory intact and reducing losses.

Through robust systems, automated procedures, and an installation of a culture of accountability, you can prevent shrinkage and safeguard your business against unseen losses. 

Contact us today for a free demo on how proactive action can ensure your profits remain intact and your operations run smoothly.