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Inventory Shrinkage as % of Sales

If you were going to implement a policy for allowable inventory shrinkage would you use gross sales or gross profit?

Answers

Anonymous
(CFO/Board Advisor) |

Neither. I would use average inventory on hand balances during the period, e.g. month or quarter.

Topic Expert
Christie Jahn
Title: CFO
Company: Prime Investments & Development
(CFO, Prime Investments & Development) |

What % of average IOH would you consider acceptable/allowable?

Sophia Hsu
Title: Sr. GL Manager
Company: Maxim Integrated Inc.
(Sr. GL Manager, Maxim Integrated Inc.) |

May I have a follow-up question? During cycle count, we realized that in several warehouses, there are SKUs with quantity higher than recorded in our inventory ledger (NetSuite). If we have never recognized E&O reserve on these SKUs, can we write up the quantity in our system to true up with warehouses' stock count?

It is understood that reversals of inventory write-downs are prohibited under any circumstances in U.S. GAAP.

Topic Expert
Christie Jahn
Title: CFO
Company: Prime Investments & Development
(CFO, Prime Investments & Development) |

Sophia, If you had SKUs with higher quantity than what was recorded when the shoot was complete would those items not gain back into inventory? We account for that.

EMERSON GALFO
Title: CFO
Company: C-Suite Services
LinkedIn Profile
(CFO, C-Suite Services) |

Sophia, I am not sure how you use "E&O Reserve" but a "reserve" is not technically a write-down. It is for all intents and purposes just an "allowance" that you can adjust up or down. As for your question, I would initially explore an "extraordinary gain" recording. However, the more important question is the record keeping and the possible cause of the difference.

Christie, I also agree with Anon on the average IOH. I do not see the utility taking the percentage from Gross Sales/Gross Profit. What is allowable is dependent on what your company will set and maybe industry standard. I would first peg it at your historical levels and decrease the allowable levels (the percentages) as time progresses.

Anonymous
(CFO/Board Advisor) |

The only acceptable number is zero. I know, I know, pretty unrealistic, huh. But here's the deal, zero has to be the goal or target otherwise you are settling for 99% or 98% or 97% or some other lesser amount. Think of it this way: The goal of every doctor and hospital is to make certain that every surgery is successful? In other words, they have a zero failure (shrinkage) goal. Would you go to a doctor or hospital whose target for success was less than 100%? And, while a 100% is rarely attained, it is still the goal. Anything less requires them to understand why, what was the cause for failure, and what can be done to fix it. Okay enough philosophy, now a practical answer:

I believe inventory shrinkage should be measured on a "gross" basis. That is no netting of overages against shortages. Every difference counts. Also, it should also be measured based upon quantities, not dollars, actual versus perpetual. There maybe items whose cost, e.g. certain electronic components cost less than a penny, actually puts them in a "who cares" category, but overall your inventory system should be rock solid tracking quantities - cost will follow. Example: you have 100,000 skus. 1,000 have actual quantities different than the perpetual quantity showing as on-hand. Now its only a "1%" error rate, but it really means that you have 1,000 skus showing the wrong quantity, which could result in an assembly stoppage, or improper reorder amounts and dates, or lost sales, or "surprise" back orders to customers. What is the cost of all of that? Most likely more than the inventory shortage.

So while I appreciate your question, I believe it should really boil down to how much will it cost to achieve a zero shrinkage rate and 100% accuracy. If it is going to cost more to achieve this, than you save, then you know what your shrinkage rate can be.

Topic Expert
Christie Jahn
Title: CFO
Company: Prime Investments & Development
(CFO, Prime Investments & Development) |

The reason for the question is we don't typically have an issue. We had set a policy a long time ago stating anything over $200 will be split and charged to the employees that work at that location. I can assure you that pretty much stopped any theft and has as long as I have worked for this company. Our stores shoot every two weeks so it's easy to see if 5 Otterbox's shrink week one but they gain back week 2 that they were missed during the count. Thus, the reason we allow for gains. We hired a new DOS who said he wasn't a fan of the $200 limit that in his experience it's typically a % of gross or net and that is where the debate comes from. So when you go from no loss to now we have a three stores close to $1,000, well I either have a theft situation or an incompetent manager who can't count. Either way, we must put an end to that issue immediately as we don't tolerate loss especially when one phone can cost close to $1,000. I think I will take back the average inventory idea to my IM and let him ponder over some solutions.

Topic Expert
Patrick Dunne
Title: Chief Financial Officer
Company: Milk Source
(Chief Financial Officer, Milk Source) |

First and foremost, I would look at your history of write offs and use that as a percentage of inventory. If you don't have that, I would establish a limit based on gross sales.

Anonymous
(Sr. GL Manager) |

Thank you, Emerson and Christie.

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