What is Shrinkage?
The Short Answer
Shrinkage explained simply
Shrinkage is when a business loses inventory for reasons other than selling it. This can happen in a few ways: theft by customers or employees, damage to products, or mistakes in recording inventory. It’s a common problem in retail and other businesses that hold physical stock. When shrinkage occurs, it means the business has less product to sell, which directly hurts its revenue and profit. It also means the business has to spend more to replace the lost items, further impacting its bottom line.
Real-World Example
The Clothing Store Example
Imagine a clothing store that starts the month with 1,000 shirts. They sell 800 shirts. At the end of the month, they count their inventory and only have 180 shirts left. This means 20 shirts are missing (1,000 - 800 - 180 = 20). These 20 shirts represent shrinkage. If each shirt costs the store $10, that’s $200 in lost inventory value due to shrinkage.
Why this matters
Shrinkage matters because it directly reduces a business’s profit. Every item lost to shrinkage is an item that cannot be sold, leading to lost revenue. It also increases operational costs because businesses often have to invest in security measures or replace lost inventory. For buyers, high shrinkage can signal poor management or security issues, making the business less attractive.
Keep a close eye on your inventory. Regular counts and good security can help you spot and fix shrinkage problems early. This protects your profits and makes your business more valuable.
Keep a close eye on your inventory. Regular counts and good security can help you spot and fix shrinkage problems early. This protects your profits and makes your business more valuable.
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Understand how factors like shrinkage impact your business valuation.
