Inventory Shrinkage - No one likes it, especially when it’s owner induced!
Every time you take stock off the shelves to feed your family, or clothes to wear out with friends, or toys for the kids or pets to play with, there’s a price to pay. You think you’re saving money because you’re only paying ‘cost price’ – the price you purchased it at from the supplier. But, in the long run it’s cost you much more because you’ve just reduced the sale price of your business when you come to sell it.
I know how great it is to grab a few things as you head out the door after a long day. You own the business, after all. You’ve paid for it all - it’s yours to do with as you will.
That’s certainly true but my aim here is to make sure that if you choose to do that, you understand the true costs to you in the long run. At least then you can make an informed decision.
An owner taking stock from their shelves without paying for it is called ‘inventory shrinkage’ and, in the long run, it could end up costing you 3 or even 4 times more than you think it does. Depending on what your goal is for your business, that might be ok for you or it might not.
LET’S LOOK AT A SIDE-BY-SIDE COMPARISON
Consider the two business owners below. One was me, and one was someone I knew. We were both retailers but we both had different long term goals for our businesses and so we had different approaches to feeding our families from our businesses.
Ok, this isn’t me but pretend I’m this good looking! I always knew that I wanted to sell my business in the fourth year of owning it. This was the perfect time for me personally and also, it would have had three years to run on the lease but also have three full years of strong financials to share. Therefore, my aim was to maximise profits to get the best price possible (which I was successful at) and so I almost never took stock from my store without paying for it.
My friend was in it for the long haul. He intended to keep his business for many years, perhaps even pass it on to his kids. He wasn’t expecting to sell it for such a long time that he didn’t mind sacrificing a bit of profit so that he could feed his family from his business. To him, his business was his pantry and he would happily grab a few things for dinner every night as he headed out the door.
NOW IT’S YOUR TURN. WHAT’S YOUR LONG TERM GOAL?
If you’ve got the same long term business goal as my friend, that’s fantastic, and you probably can take a ‘feeder’ approach to your business but if you change your mind along the way, just know that you could be reducing your sale price if you are taking a lot of inventory out of your business for your personal use.
“This is called inventory shrinkage. No one likes shrinkage, especially when it’s owner-induced!”
DON’T BELIEVE ME? LET ME PROVE IT.
Business Selling 101 tells us that you won’t get the best price for your business if all the time you’ve been taking money out of it.
How does that work? Well, let’s just imagine that, as the owner, you’ve taken $10,000 worth of stock (at cost) over the year for personal use and it’s not recorded as a sale – you either write it off through the POS or you don’t even bother recording it at all.
Two things happen:
Reduced profit: That stock that you’ve taken didn’t generate sales that would have looked great in your financial figures when you go to sell.
Reduced inventory: And also, that’s now $10k of inventory that is no longer on your books; it isn’t appearing in your stock at valuation. Its value has simply disappeared.
Now, remember what I told you on this page about the multiplier? That’s the number that is used to multiply your average annual profits by to calculate your business valuation. That’s the kicker here – that’s why the stock that you took is going to cost you a lot more in the long run. Not only did you lose the chance to make money from those items at the time, you’re now missing out on having the profit that could have been made for them included in the calculations for the business sale - their value would have multiplied!
Check out the two businesses below, this will help explain it.
Sarah, the owner of the first business doesn’t take any stock from the shelves unless she pays for it – she considers herself a customer just like everyone else. On the other hand, Mark thinks of his shop as his personal pantry – he feeds his family very nicely.
In this example, we will assume that both sell their businesses about the same time and all other things are equal, and we will assume that the industry multiplier used for the valuation is 3x, which is fairly average for a good small business.
Let’s see how that works out for them both when it comes time to sell.
THE TRUE COST OF INVENTORY SHRINKAGE
| SARAH'S BUSINESS (Pays for her own stock) |
MARK'S BUSINESS (Takes stock without paying) |
|
|---|---|---|
| Annual Gross Revenue | $500,000 | $490,000 |
| Cost of Goods Sold (COGS) | $200,000 | $200,000 |
| Operating Expenses | $250,000 | $250,000 |
| Normal Net Profit | $50,000 | $40,000 |
| Inventory Value (at cost) | $75,000 | $65,000 |
| Profit Multiplier (industry avg) | 3x | 3x |
| BUSINESS VALUATION | $225,000 | $185,000 |
Business Valuation = (Net Profit x 3) + Inventory
The true cost of the $10,000 worth of stock to Mark is now $40,000! By the time he goes to sell, he’s paid four times what he thought he was paying to feed his family and, worse than that, he would have been better off just going down the road to his competitor and paying normal retail price.
Meanwhile, Sarah paid HER business the normal retail price when she bought her items and, in doing so, made her profits look good. When she goes to sell, not only will her business look more profitable than Mark’s but she will also get a much better price.
“As is the case for most things in life, you can’t have it both ways. You can’t have your cake and eat it too.”
SO, WHAT’S THE TAKEAWAY HERE?
I’m not saying that as a business owner you shouldn’t take stock from your shelves (well, yes I am actually). You can certainly do that if you wish - it is one of the secret pleasures of owning a business! But just make sure that you really understand the true cost when you do partake from your store’s shelves, and make a decision as to how that sits with your long term financial goals.