By Graham Hoffman on November 22, 2022

What is Inventory Shrinkage in Retail? 8 Ways to Prevent It

There are nearly 152,000 small specialty retail stores in the United States. And every year, they lose a combined $45 billion in retail inventory shrinkage. How much of that is coming from your store?

It may be more than you know. But knowing is half the battle. The other half is implementing anti-shrinking actions and policies in your retail store. While important year-round, these actions are even more important during high-traffic periods like the holidays.

To help you combat inventory shrinkage, we’ll discuss what shrinkage is (hint: it’s not just theft). Then, we’ll look at practical ways to prevent shrinkage in your store and how your point of sale (POS) system can help achieve this goal. You’ll take away immediate action items to reduce and prevent shrinkage, and build a more profitable business.

Defining Retail Inventory Shrinkage

Retail shrinkage is when your store has fewer items in stock than recorded in your inventory.

All retailers face shrinkage. Even the most seasoned small business owners encounter employee theft and shoplifting. But these aren’t the only reasons for shrinkage woes. You can also factor in administrative errors like pricing, record keeping, and cash counting. Vendor fraud accounts for a small percentage of shrinkage.

8 Effects of Shrinkage On Small Retail Businesses

The effects of shrinkage are far-reaching and lead to money coming straight out of your pocket. 

  1. Lost Revenue: You lose revenue when your cash registers come up short or merchandise is damaged or stolen.
  2. Price Increases: To account for lost revenue, you might need to raise prices. Your customers will have to pay more, which might put you at a competitive disadvantage.
  3. Purchasing Capacity: Vendors may decrease your credit or freeze your account if you can’t pay your invoices on time. In turn, you won’t be able to purchase stock and could lose sales opportunities.
  4. Staff: To make up for lost revenue, you may need to decrease wages or hours, and staff might leave as a result. If you fire employees who steal, you need to hire new staff to replace them. You’ll also have to onboard and train them. In the end, bad hires cost more.
  5. Decreased Profitability: Retail profit margins are already thin. Shrinkage is a loss and could put you in the red, affecting other aspects of your business.
  6. Increased Security Costs: To combat employee theft and shoplifting, you’ll need to implement tighter security measures, such as security cameras and more security guards.
  7. Higher Debt Ratios: You can leverage debt to help grow your business. But shrinkage causes debts to pile up. You might need to rely on credit to keep your store running. As you lose revenue, cash flow is diminished.
  8. Time Lost: If you’re forced to spend more time on loss prevention, you’ll lose time you could be spending on training, staffing, promotional efforts, or other parts of your business.

The bottom line is shrinkage significantly impacts your revenue and relationships with customers and employees.

So How Do You Prevent Inventory Shrinkage? Try These 8 Tips

1. Track Stock Levels in Real Time
2. Set Strict Employee Controls for Your POS System
3. Conduct Regular Cash Drawer Counts
4. Install Anti-Theft Cameras & Signs
5. Use RFID and RF Security Tags
6. Rethink Your Store Layout
7. Audit Your Return and Exchange Policies
8. Ensure Training Includes Best Practices for Fighting Inventory Shrinkage

1. Track Stock Levels in Real Time

Lack of visibility into your inventory makes it harder to spot shrinkage. The best way to remedy this is to track inventory in real time. The right POS system tracks everything you need to compare sales to inventory counts. For example, the products are immediately deducted from the item count every time you make a sale.

You’re already aware that manual inventory methods are error-prone. A miscount or typo leads to inaccurate inventory counts and adds more problems to your plate. Manual processes are also time-intensive, and it’s harder to spot discrepancies in real time.

Related: Automated Inventory Management: Why It's a Critical Feature for Retailers [EXAMPLES]

With up-to-date inventory, you won’t need to go back and count what’s in stock every week. You’ll have the data available to determine if there are any discrepancies when the time comes for monthly, quarterly, or yearly inventory counts.

The inventory feature of a POS system is also helpful in managing damaged items. The software makes it easy to track broken products and document why they were taken off the shelf. Using historical data, you can see which products get damaged the most.

2. Set Strict Employee Controls for Your POS System

There are certain areas of your POS system that employees don’t need and shouldn’t have access to. For example, a new employee doesn’t need access to inventory management, transaction reports, vendor management, or cash drawers.

The best place to start is to set employee permissions based on their role and experience, and control who can perform specific actions. Your POS software should let you access and change permissions in a few clicks.

For example, a new cashier can only complete standard transactions once logged in. They’ll need a manager if they want to add a discount or process a return. Once they've gained your trust, you could permit them to perform discounts and returns.

You could also use the team-tracking software to check who logs in, at what time, when they take breaks, the cash register they’re using, and the transactions they perform.

Lastly, you might find a discrepancy in your inventory report. An item was reported as damaged, but there aren’t any damaged items in the back room. Did someone on your team lie about the damage so they could keep it for themselves? Use your POS software to find out.

Related: 5 Employee Theft Laws Business Owners Need to Be Aware Of

3. Conduct Regular Cash Drawer Counts

It can be challenging to detect and prevent cash skimming without robust security measures. An excellent place to start is reconciling each register at the end of an employee’s shift. This ensures that your employee knows you’ll check their cash drawer immediately instead of at the end of the day.

Only some discrepancies are nefarious. Many are human errors and lead to shortages and overages. Overages usually mean your employee short-changed a customer — perhaps your employee needs more training — and shortages could mean cash is lost or miscounted.

However, there’s another way to determine if a cashier is stealing. You know what’s in each cash register at the beginning of the day, but your cashier doesn’t need to know. Turn on blind counts so your cashiers don’t know what’s supposed to be in their drawers. Count the drawer at the end of their shift and find any discrepancies.

Look out for these red flags: excessive refunds in small amounts, too many voided transactions, and product returns that don’t match merchandise.

The right POS system should record accurate data, whether you compare counts at the end of each shift or each day. This helps you catch things that day versus the week's or month's end.

It should be easy to spot minor or significant discrepancies, see which employees are logged into your system, and what transactions they approve.

4. Install Anti-Theft Cameras & Signs

A simple way to stop shoplifting is to deter customers with security measures like anti-theft cameras. People act differently when they know they’re being watched.

If you have a small store, you might only need one or two cameras, but larger stores with register blind spots may need three or more.

With video transaction matching, you can automatically match transactions with video footage. Essentially, the video footage is bookmarked when a transaction is made.

Transactions can then be searched and analyzed. If you link your security systems to your POS system, you’ll have remote access to view video feeds from anywhere, meaning you can stop theft in real time.

Other benefits of video security include:

  • You can use real footage to train employees on suspicious behavior and how thieves get away with stealing.
  • 24-hour coverage of your store can capture all activities and incidents outside of regular business hours.
  • You have visibility throughout the store, whether there's a shoplifting incident or an employee theft.

Pro tip: Simply having signage for surveillance and prosecution of shoplifters can be a good deterrent.

5. Use RFID and RF Security Tags

Isn’t it embarrassing when you walk too close to anti-shoplifting sensors at the front of a store while holding merchandise in your hand and the alarm starts ringing?

This is an example of RF (radio frequency) or RFID technology in action. The difference between RF and RFID is that RF notifies of the theft of an item, but RFID can pinpoint the exact item being stolen.

RF works by having a transmitter and receiver at the door, and every item in the store contains a concealed RF tag. In most retail stores, these are hard tags bolted on. Sometimes, the tags are ink-loaded. If a customer tries to remove the tag, the ink spills out and ruins the item they’re trying to steal.

Related: GUIDE: Minimizing Theft, Improving Security, and Increasing Profits for Your Small Business

6. Rethink Your Store Layout

To deter theft, consider your store layout, especially any blind spots. Clever thieves use quiet corners and areas with tall shelves to hide items they’ll come back to steal later.

While you need more inventory on the shop floor to sell more, stacks and vertical displays may cause obstructed views. Also, your store might feel disorganized when you have too many items on display. Items left in the wrong sections are ideal targets for thieves.

The best practice is to have cash registers at the front of the store. Customers will have to pass them as they leave, and staff will have a better chance of catching thieves. Limit the number of high-priced items on the floor, but also place these near registers or in hard-to-access areas, so thieves have one last hurdle to get over before leaving your store.

Depending on the size of your store, the number of employees you have can be a deterrent to thieves. It’s essential to have an employee on each register, one or two on the shop floor, and security guards.

7. Audit Your Return and Exchange Policies

You can build customer loyalty and trust with a robust return and exchange policy. Customers appreciate having a safety net in case their items don’t fit or aren’t what they expected once they get home. However, while you want to be fair to customers, it can’t be at the expense of losses for your store.

It's best to manage your customers' expectations from the start. A survey found that 49 percent of customers check for a return policy before buying anything, so having your policy on display might be good.

You can do a few things to ensure your return and exchange policies don’t cost you money:

  • Require receipts for cash purchases. No receipt, no refund.
  • Require manager approval for refunds and voids.
  • Require customers to show a valid ID for every return and exchange.
  • Require the customer to return the items in a suitable condition.
  • Offer store credit instead of a cash refund. This can incentivize customers to spend the same or more on a return visit.
  • Let the customer know there’s a deadline for return; the best practice is a maximum of 30 days.

If you don’t display your policy, customers have to call you with their questions. Your time is better spent elsewhere. 

The right POS system allows you to process returns and refunds easily, and the system should track all the data for you, down to why the items were returned.

Who can process returns and refunds? That’s up to you. You want managers and keyholders to process them, but in busier periods, like the holidays, you might be comfortable with cashiers processing returns and refunds. In that case, your POS software should make it easy to change permission.

8. Ensure Training Includes Best Practices for Fighting Inventory Shrinkage

The best defense is offense. If you don’t train your staff on preventing shrinkage, you’re leaving your store open to employee theft, shoplifting, and unnecessary errors.

Employees should know the effects of shrinkage and the steps your business takes to ensure it happens less. Tell employees why they only have specific permissions and educate them on what to look for. 

It’s too easy for staff to be taken advantage of. Show them the common tricks shoplifters and return fraudsters use. You’ll also get more buy-in from employees if they are part of your defense against shoplifting and theft.

Arm them with the best tools. As well as easy-to-remember, repeatable processes, provide POS technology that makes inventory management easier and doesn’t force them to use manual methods. 

Lastly, training your employees to use your POS system is essential. 

During onboarding, ensure training focuses on the features your employees will use the most, and provide hands-on experience. You can run test transactions, and some POS solutions allow retailers to simulate common problems, such as declined credit cards.

Your POS System is the First Line of Defense Against Inventory Shrinkage

As we said at the beginning, shrinkage isn’t just theft; it’s also caused by admin and internal errors.

Robust inventory management, employee controls, blind cash drawer counts, transaction reporting, and recording employee actions are all ways your POS can help.

POS Nation’s retail software includes these safeguards and more to protect your retail business from all forms of shrinkage. We also help with team training and onboarding to prevent admin and internal errors.

The best part: it’s cost-effective for retail businesses of all sizes. You can customize your POS system to your needs in three simple steps.

Step 1: Check out the retail store POS page to learn more.

Step 2: Schedule a demo to see it in action.Step 3: Build your perfect POS system with our Build and Price tool.
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