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What is the best way to identify shrinkage in inventory forecasting models?

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Shrinkage is the difference between the expected and actual inventory levels due to various factors such as theft, damage, miscounting, or spoilage. It can have a significant impact on the accuracy and profitability of inventory forecasting models, which are used to plan and optimize inventory decisions based on historical data and future demand. In this article, you will learn what are the best ways to identify shrinkage in inventory forecasting models and how to reduce its negative effects.

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1 Why is shrinkage important?

Shrinkage is important because it affects the key performance indicators (KPIs) of inventory management, such as inventory turnover, service level, fill rate, and gross margin. If shrinkage is not accounted for in inventory forecasting models, it can lead to overstocking or understocking, which can result in lost sales, excess inventory costs, customer dissatisfaction, or wasted resources. Therefore, it is essential to measure and monitor shrinkage regularly and adjust inventory forecasting models accordingly.

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George Kafui Vallings

Warehouse & Inventory Manager, Ernest Chemists Limited Accra, Ghana
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I think it’s also important to identify the courses of inventory shrinkage. Poor inventory records may be leading factor of over ordering. In many instances, in some large warehouses some amount of inventory maybe forgotten to expired due to slow of sales. Unless daily stock check is prompted. During demand forecasting all stores and warehouses are to be cross-checked to ascertain the actual levels of stock. Shoplifting is when some customers do away with products they can’t afford. CCTV and electronic tags can curb the situation. Internal theft by staff. Over supply to regular customers undetected. Wrong description of products with correct quantities and sometimes Port theft during customs examinations. Rodents are not left out.

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2 How to measure shrinkage?

The simplest way to measure shrinkage is to compare the physical inventory count with the book inventory, which is the recorded inventory in the system. The difference between the two is the shrinkage amount, which can be expressed as a percentage of the book inventory or the sales value. For example, if the book inventory is 100 units and the physical inventory is 90 units, the shrinkage amount is 10 units and the shrinkage percentage is 10%. Alternatively, if the sales value of the book inventory is $1,000 and the sales value of the physical inventory is $900, the shrinkage amount is $100 and the shrinkage percentage is 10%.

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George Kafui Vallings

Warehouse & Inventory Manager, Ernest Chemists Limited Accra, Ghana
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At this level it should be ascertained whether inventory shrinkage is a continuous phenomenon or one time issue. This helps in accurately forecasting demand. If there was 5% inventory shrinkage, should it be factored in the next order or it should be well ascertained if it’s continuous issue. By this we can determine whether to increase the next order by 5%. So getting the % of shrinkage is not enough. The rate of occurrence should seriously be factored in. Shrinkage through poor temperature, overstocking, and internal theft and damages should be not factored in demand forecasting bcos they can easily be controlled. Appropriate measures can be put in place to curb the situation. Staff may pay for the shrinkage if it’s their negligence.

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3 How to identify shrinkage in inventory forecasting models?

One way to identify shrinkage in inventory forecasting models is to compare the forecasted demand with the actual demand. If the forecasted demand is consistently higher than the actual demand, it may indicate that shrinkage is occurring and reducing the available inventory. Another way to identify shrinkage in inventory forecasting models is to compare the forecasted inventory level with the actual inventory level. If the forecasted inventory level is consistently lower than the actual inventory level, it may indicate that shrinkage is occurring and inflating the book inventory. A third way to identify shrinkage in inventory forecasting models is to analyze the root causes of shrinkage, such as theft, damage, miscounting, or spoilage, and track their frequency and severity.

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4 How to reduce shrinkage in inventory forecasting models?

In order to reduce shrinkage in inventory forecasting models, there are several strategies to consider, depending on the source and type of shrinkage. For example, implementing security measures like locks, cameras, alarms, or RFID tags can help prevent theft. Additionally, improving inventory handling and storage practices can help avoid damage or spoilage. This could include proper packaging, labeling, temperature control, or rotation. Enhancing inventory counting and recording procedures can also prevent miscounting or errors. This could involve barcode scanning, cycle counting, or automated reconciliation. Finally, adjusting inventory forecasting models to account for shrinkage is important. This could include incorporating shrinkage factors, updating historical data, or using probabilistic methods.

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5 How to evaluate the impact of shrinkage on inventory forecasting models?

The impact of shrinkage on inventory forecasting models can be evaluated by measuring the accuracy and profitability of the models before and after accounting for shrinkage. The accuracy of the models can be measured by using metrics such as mean absolute percentage error (MAPE), mean absolute deviation (MAD), or mean squared error (MSE), which compare the forecasted values with the actual values. The profitability of the models can be measured by using metrics such as return on investment (ROI), net present value (NPV), or internal rate of return (IRR), which compare the benefits and costs of the inventory decisions. By comparing the metrics before and after accounting for shrinkage, the impact of shrinkage on inventory forecasting models can be quantified and analyzed.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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What is the best way to identify shrinkage in inventory forecasting models?

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6

1 Why is shrinkage important?

2 How to measure shrinkage?

3 How to identify shrinkage in inventory forecasting models?

4 How to reduce shrinkage in inventory forecasting models?

5 How to evaluate the impact of shrinkage on inventory forecasting models?

6 Here’s what else to consider

Inventory Management

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What is the best way to identify shrinkage in inventory forecasting models?

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5

6

1 Why is shrinkage important?

2 How to measure shrinkage?

3 How to identify shrinkage in inventory forecasting models?

4 How to reduce shrinkage in inventory forecasting models?

5 How to evaluate the impact of shrinkage on inventory forecasting models?

6 Here’s what else to consider

Inventory Management

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