Shrinkage refers to any reduction in inventory not accounted for by sales, returns, or transfers. Causes include theft, administrative errors, miscounts, or damage during storage. Shrinkage directly affects profit margins and is often uncovered during audits or stock takes. For example, if 100 units of a product were received but only 95 remain after a month without corresponding sales, a shrinkage event has occurred and must be logged, investigated, and reported.