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Understanding your shrink.

Throughout the loss prevention and security industry shrink means the loss of cash or merchandise due to a complex combination of internal and external thefts in addition to internal management computational errors.

But how is shrink actually calculated? What elements of the retail business are affected? And do different kinds of shrink - the theft of cash as opposed to inventory - affect operations in similar ways.?

All shortages combine to weaken the retail enterprise, and, therefore, management must treat all of them as potentially serious threats to operations. As with any concern of management, internal losses their effect and nature - must be thoroughly understood to be resisted effectively.

Often investigative priorities are dictated by the size of the loss. However, when brought about by serious thefts such as the appropriation of deposits or till tapping, smaller shortages cannot be long ignored because of the extraordinary consequences that will arise. Once time and resources are allocated to investigate a theft, the kind of shortages directly affecting sales or inventory will dictate what loss prevention techniques will be required to interdict them.

The impact of theft on a corporation is rarely felt until the end-of-the-year financial statements are prepared. If the theft goes undetected, the reconciliation of end-of-the-year inventories and net sales will have surprising results.

Retail operating shortages caused by theft manifest themselves in only two discernable ways: reduced sales and changes in inventory levels.

The retail industry's most commonly encountered kinds of thefts can be divided into two classifications: external, which includes shoplifting; and internal, which includes sales voiding, refund fraud, underringing, till tapping, and deposit theft.

Corporate fraud is excluded from the scope of this analysis. Its omission is not intended to imply a reduced sense of concern for this kind of theft, but to emphasize the effects of shrinkage caused by the most frequently encountered larcenies.

Shrinkage caused by shoplifting reduces inventory. Sales volume, however, remains unaffected given that consumer demand remains constant. This simple cause-and-effect relationship represents one of the most elementary effects of shrinkage. Exhibit 1 illustrates the impact of inventory losses on a retailer's sales-to-inventory ratio.

When in equilibrium, a normal sales level (NSL) is supported by a normal inventory level (NIL). If inventory (NIL) shrinks, however, it must be replaced to satisfy the otherwise unchanged consumer demand. Consequently, the normal volume of sales can no longer be supported by its normal inventory level due to the imbalances resulting from theft. Instead, inventory will have to be replaced, thereby increasing NIL to the adjusted inventory level (AIL).

This expansion of inventory will force operating profits to contract. When inventory expands, the retailer will generate less profit per transaction because the costs and outlays for replacement stock will rise while sales remain constant. In an inflationary economy, the costs to replace inventory will rise, driving profit margins down even further.

Underringing affects the retailer in the same way that shoplifting does: Inventory travels out the door without having been sold at its market price. It's as if the shoplifter or employee decided it was safer to steal only a fraction of an item rather than the whole thing.

What about the effect of internal theft on retail operations? Exhibit 2 demonstrates the result when employees steal cash by voiding customer sales or issuing fraudulent cash refunds.

In these instances, sales volume is reduced, creating artificially lower levels of demand. Unfortunately, the inventory quantity remains constant while sales (NSL) contract downward to an adjusted sales level (ASL). Downward pressure on sales creates essentially the same effect on profitability caused by the upward pressure resulting from an expanding inventory, albeit for the different reasons already discussed.

The effects of shrinkage on sales and inventory are more complex when employees till-tap or steal deposits before they are credited at the bank. For instance, if an employee steals a deposit corresponding to a specific sales date, reported earnings still remain the same. Unfortunately, the cash corresponding to those reported sales is not available for operations and, once again, inventory will have to be replaced with capital diverted from other intended uses.

Consequently, when cash received for legitimate transactions is stolen, the retailer pays a double penalty: Both cash and inventory must be replaced. Exhibit 3 illustrates this worst case scenario.

Because inventory must be purchased, NIL moves upward to AIL. Because sales deposits, in this case NSL, are lost, NSL moves downward to ASL. Profit is squeezed twice by the simultaneous downward and upward shift of cash and inventory.

Changes in inventory and revenue created by the incidence of theft are interrelated but do not always manifest themselves the same way. While all theft is detrimental, some kinds of theft are more disruptive to retail operations than others. To the extent that they are, loss prevention managers must prioritize their investigations so they can respond to theft-related problems based on a commonsense cost-benefit rationale.

Understanding what kinds of theft are the most threatening provides loss prevention managers with an early warning to address shortage problems and minimize losses quickly. A loss prevention program must be based on a preventive strategy if shortages are to be reduced. Security managers who pursue short-term objectives and follow a crisis-oriented reactive strategy invite disaster, for their employers as well as themselves.
COPYRIGHT 1990 American Society for Industrial Security
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1990 Gale, Cengage Learning. All rights reserved.

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Title Annotation:inventory shortages
Author:Masuda, Barry
Publication:Security Management
Date:Jul 1, 1990
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