How to Calculate Inventory Shrinkage Rate
Inventory shrinkage rate quantifies the gap between what the inventory system says you have and what you actually count. It is a critical loss-prevention and operational accuracy metric because it surfaces theft, damage, scanning errors, and timing mismatches that can quietly erode profit. When shrinkage climbs, it distorts replenishment signals and inflates safety stock requirements.
This walkthrough explains how to compute shrinkage rate, defines every variable with units, and details a validation workflow. It also connects shrinkage analysis to operational levers such as warehouse order picking productivity, accuracy monitoring through OTIF delivery rate, and inventory policy tuning with the inventory reorder point calculator.
Definition and purpose
Shrinkage rate is the percentage difference between book inventory and physical inventory. Book inventory is the expected balance from your ERP or inventory management system. Physical inventory is the counted balance from a cycle count, audit, or full physical inventory. The rate expresses how much of the expected inventory is missing or unaccounted for.
The metric can be expressed in units or dollars, but finance teams typically track it in cost-based dollars to quantify margin impact. A positive shrinkage rate indicates loss. A negative rate indicates overage, which often flags receiving errors or misposted adjustments.
Variables, symbols, and units
Ensure both inventory values are taken at cost and refer to the same cut-off date.
- B – Book inventory value at cost, unit: USD.
- P – Physical inventory value at cost, unit: USD.
- L – Inventory loss amount, L = B − P, unit: USD.
- SR – Shrinkage rate, unit: percent.
Core formula
Shrinkage rate is the loss amount divided by the book inventory balance.
Loss amount (L) = B − P
Shrinkage rate (SR) = (L ÷ B) × 100
When P exceeds B, the loss amount is negative and the shrinkage rate is negative, signaling an overage. Keep the sign for transparency rather than forcing it to zero.
Step-by-step calculation workflow
Step 1: Align the cut-off date
Lock the ledger at a specific time and ensure receipts, shipments, and transfers are posted consistently. Any timing mismatch will distort shrinkage and lead to false positives.
Step 2: Capture book inventory
Extract the book inventory balance at cost from your inventory system. If your ledger holds multiple cost layers, use the weighted average or FIFO balance that aligns with financial reporting.
Step 3: Conduct a physical count
Perform a cycle count or full physical audit and convert the quantities to cost-based values. Document any adjustments for damaged or expired goods separately so you can distinguish procedural losses from shrinkage.
Step 4: Calculate and document shrinkage
Subtract the physical value from the book value, divide by the book value, and multiply by 100 to obtain the shrinkage rate. Round to two decimals and store the supporting balances for audit review.
Validation and reconciliation checks
Reconcile the loss amount with inventory adjustments posted in the general ledger. If the shrinkage amount exceeds your tolerance, drill into high-variance SKUs, locations, or shifts. Use variance reports to isolate whether the loss stems from theft, damage, administrative errors, or timing issues.
Confirm that cost standards and valuation methods match finance policy. A mismatch between standard cost in inventory systems and actual cost in finance can introduce artificial shrinkage that is not operationally meaningful.
Build a reconciliation log that ties shrinkage movements to known events. Examples include stock transfers in transit, unposted returns, and cycle counts that were partially completed. When shrinkage is concentrated in a subset of locations, compare staffing levels, receiving practices, and access controls to separate process gaps from malicious loss. Consistent documentation makes it easier to defend the results during audit reviews and to prioritize corrective actions that reduce future shrinkage.
Limits and interpretation
Shrinkage rate is a point-in-time metric, so it should be trended over multiple cycles before making staffing or security investments. Short-term spikes can reflect counting errors, while persistent increases signal control gaps. Avoid comparing rates across stores or warehouses unless count accuracy and product mix are similar.
Shrinkage does not capture lost sales from stockouts or excess inventory. Combine it with service metrics and replenishment KPIs to ensure that loss-prevention action does not create new supply issues.
If you track shrinkage in dollars, remember that rising unit costs can inflate the rate even when unit losses are stable. Document whether the metric is calculated at standard cost, weighted average cost, or another valuation basis so trend comparisons stay consistent across reporting periods.
Worked example
A distribution center shows $500,000 in book inventory at cost. A physical count shows $487,500. The loss amount is $12,500. Shrinkage rate is $12,500 divided by $500,000, which equals 2.50%. If the company tolerance is 2.00%, the result is 0.50 percentage points above the acceptable range and warrants a root-cause review.
Embed: Inventory shrinkage rate calculator
Use the embedded calculator to record book and physical inventory values, quantify the loss rate, and compare the output to your shrinkage tolerance.