In accounting and retail, shrinkage, often shortened to shrink, means inventory shrinkage: the difference between the inventory a business's records say it should have and the inventory actually found when it is counted. The main entry explains how shrinkage is measured, recorded and controlled.
What causes it
Shrinkage has a handful of usual sources: shoplifting, employee theft, supplier fraud such as short deliveries, administrative and pricing errors, and goods damaged, lost or spoiled before they could be sold. Perishable products suffer from spoilage, and some goods lose weight or volume naturally through evaporation or trimming.
It can only be found by comparing the records with a physical inventory count. Under a perpetual inventory system, the count is compared with the running balance and the difference is written off, usually to cost of goods sold or a separate inventory loss account. Under a periodic system, shrinkage is not identified separately and is simply absorbed into cost of goods sold.
Retailers usually express shrinkage as a percentage of sales. Even a rate of one or two percent matters in a business with thin margins, because every lost item reduces gross margin directly. High or rising shrinkage can also point to weak controls or fraud.
Outside accounting, "shrinkage" has other meanings, such as a fall in the size of an economy or market, but in bookkeeping and retail it almost always refers to lost inventory.