Unknown shrinkage: definition, calculation and causes
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Do you know what portion of your profit margin is lost outside of the price?
Schedule a meetingDiscover our pricing optimization softwareShrinkage is the difference between the theoretical stock , calculated from recorded purchases and sales, and the actual stock counted during an inventory. It includes losses whose cause is not recorded: external theft, internal theft, administrative errors, and unreported breakage. It directly reduces profit margins but cannot be controlled through pricing.
The Essentials in 6 Questions
Inventory losses whose cause is not recorded.
Store management, management control , security, logistics.
Measured at each inventory , continuously monitored on sensitive products.
By store , department and product family.
Protect the profit margin that the prices have allowed us to generate.
Theoretical stock − actual stock , relative to sales.
How do you calculate the unknown shrinkage?
We compare what the stock should be with what it actually is, then we relate the difference to the sales figures.
| Indicator | Formula |
|---|---|
| Theoretical stock | Initial stock + recorded entries − recorded exits (sales, breakages and markdowns declared) |
| Unknown markdown | Theoretical stock − actual stock recorded during inventory |
| Unknown shrinkage rate | Unknown shrinkage ÷ period revenue × 100 |
The markdown is valued at the purchase price or the selling price: it is necessary to specify the convention used to compare two stores or two periods.
Example of calculating shrinkage
A store whose theoretical stock is worth €250,000 and inventory €246,000 finds €4,000 of unknown shrinkage.
Unknown shrinkage: €250,000 - €246,000.
Markdown rate: €4,000 ÷ €400,000 turnover.
The lost value is lost outside the margin, without any sales to offset it.
Each euro of unaccounted-for markdown wipes out several euros of sales margin: that's what makes it so costly.
The causes of shrinkage
Four categories of causes, each requiring different levers.
| Cause | Examples | Levers |
|---|---|---|
| External flight | Shoplifting, self-checkout fraud | Security, anti-theft measures, and the placement of sensitive products |
| Domestic flight | Misappropriation of goods, complicity | Controls, segregation of duties, anomaly tracking |
| Administrative errors | Incorrectly entered receipt, labeling or cash register error | Acceptance testing, reliability of reference data |
| Breakages and unreported losses | Damaged or expired products were discarded without registration. | Reporting procedures, tracking dates |
Unknown markdown, known markdown, markdown: don't confuse them
Three concepts that reduce the margin, but are neither measured nor corrected in the same way.
- Known shrinkage : recorded losses, the cause of which is known (reported breakage, expired products removed, donations).
- Unknown shrinkage : the unexplained discrepancy found in the inventory.
- Markdown (trade markdown) : a voluntary price reduction to clear stock, see clearance and markdown .
Only markdown is driven by price; shrinkage is a matter of process control, security, and reliability. Both are reflected in the net margin .
Frequently Asked Questions
Short answers to the most frequently asked questions about shrinkage.
What is shrinkage?
Shrinkage is the difference between a store's theoretical stock, calculated from recorded purchases and sales, and the actual stock found during a physical inventory count. It encompasses all losses whose cause has not been recorded: shoplifting, internal theft, receiving or cash register errors, breakage, and expired products discarded without being declared. It directly impacts profit margins, since the missing merchandise has been paid for but not sold. Unlike markdown, it is not corrected through price adjustments, but through process control and reliability.
How do you calculate the unknown shrinkage?
To calculate shrinkage, we start with the theoretical stock: initial stock + recorded receipts − recorded issues, whether these are sales, declared breakages, or known shrinkage. We then compare this to the stock actually counted during inventory: shrinkage = theoretical stock − actual stock. Expressed as a percentage of the period's revenue, this gives the shrinkage rate. For example: a €4,000 difference on €400,000 in sales represents a rate of 1%. It is always specified whether the shrinkage is valued at the purchase price or the selling price.
What is the difference between known shrinkage and unknown shrinkage?
Known shrinkage encompasses recorded losses for which the cause is known: reported breakage, expired products removed from sale, damaged items, and donations. Unknown shrinkage is the unexplained discrepancy between theoretical and actual stock levels during inventory. The former can be managed through procedures, such as better date management or reducing shrinkage in the back stock; the latter requires first identifying the cause: theft, error, or unreported loss. A portion of unknown shrinkage often stems from known shrinkage that simply went unrecorded.
What are the causes of shrinkage?
The causes of shrinkage fall into four categories. External theft, such as shoplifting or fraud at self-checkout machines. Internal theft, through merchandise diversion. Administrative errors: incorrectly recorded receipts, labeling errors, cash register errors, or incorrect product codes. Finally, breakage and unreported losses, such as damaged or expired products discarded without being recorded. Their prevalence varies depending on the store format and the products sold; small, high-value items are the most vulnerable to theft.
How to reduce shrinkage?
To reduce shrinkage, we begin by measuring it precisely, by department and by product category, to pinpoint where it is concentrated. We then address each cause: securing and storing sensitive products to prevent external theft, implementing controls and segregating duties to prevent internal theft, using receiving checks and reliable reference systems to prevent administrative errors, and establishing reporting procedures to prevent unrecorded breakage. More frequent cycle counts of high-risk products allow us to identify discrepancies before they accumulate.
What is the impact of shrinkage on the profit margin?
The impact of shrinkage on profit margin is direct: each lost item has been paid for without generating a sale, and its value is entirely lost to the margin. This is why even a small percentage of shrinkage can wipe out a significant portion of the profit. With a 25% markup rate, you need to sell €4 worth of merchandise to generate €1 of profit: €1 of shrinkage cancels out the €4 of sales margin. Pricing strategies protect the gross margin ; combating shrinkage protects what remains of it.
Key Takeaways
- Unknown shrinkage = theoretical stock − actual stock at inventory.
- Four causes: external theft, internal theft, errors, unreported breakage .
- It reduces the margin but is not driven by price , unlike markdown.
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