Inventory shrinkage: what it is and how to record it
Shrinkage is the gap between the stock your records say you have and the stock actually on the shelf. Every product business has some. The goal is to measure it, record it and keep it small.
Where shrinkage comes from
- Paperwork errors: receiving the wrong quantity, a sale recorded twice, a unit-of-measure mix-up
- Supplier short shipments that were never counted on arrival
- Damage and spoilage that isn't written off when it happens
- Theft, by customers or staff
Paperwork errors are often the biggest and easiest to fix, which is why careful receiving matters.
How to calculate your shrinkage rate
Shrinkage rate = (inventory per records − inventory counted) ÷ inventory per records
If your records show $50,000 of stock and the count values it at $48,750, shrinkage is $1,250 and the rate is $1,250 ÷ $50,000 = 2.5%. Use the same costs on both sides so the comparison is fair.
How to record it
After the count, reduce inventory to what you actually have. Using the example above:
Debit inventory shrinkage $1,250 · Credit inventory $1,250
Many businesses keep inventory shrinkage within cost of goods sold, so gross margin reflects it. Record damaged or expired goods when you find them, rather than waiting for the count, and keep a note of why.
How to reduce it
- Receive against purchase orders and count every delivery on arrival. See the purchase order process.
- Cycle count: count a few items every week instead of everything once a year, starting with high-value and fast-moving items.
- Investigate big differences before adjusting. A miscounted delivery or duplicate sale can often be corrected.
- Limit access to stock rooms, and separate who receives goods from who records them where you can.
- Track damage and returns as they happen, with a reason.
Common questions
What is a normal shrinkage rate?
It varies a lot by industry and how products are stored and sold. Track your own rate over time and investigate when it rises.
Is shrinkage tax deductible?
Lost or damaged inventory generally reduces your taxable income through cost of goods sold, but rules vary, so check with your tax professional.
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This guide is general education, not tax, legal or accounting advice. Rules vary by business and location, so confirm your situation with a qualified professional.