Is ABC Analysis Affecting Your Inventory Stock?

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The ABC analysis is an inventory categorisation technique. It can be put to use for a wide range of inventory items, such as manufactured products, components, spare parts, finished goods, unfinished goods or sub-assemblies. The ABC analysis suggests that inventories of an organisation are not of equal value. Thus, the inventory is grouped into three categories (A, B, and C) in order of their estimated importance. ABC analysis divides an inventory into three categories: “A” with very tight control and accurate records, “B” which are less tightly controlled but still have good records, and “C” items which have the simplest controls possible and minimal records. Furthermore, the ABC analysis provides a mechanism for identifying items that will have a significant impact on overall inventory cost, while also providing a mechanism for identifying different categories of stock that will require different management and controls.

ABC Categories explained

Using this analysis, “A” items are very important for an organisation. Because of the high value of these items, frequent value analysis is required. In addition to that, an organisation needs to choose an appropriate order pattern, for example, Just-In-Time (JIT) inventory to avoid excess capacity. “B” items are important, but of course less important than “A” items and also more important than “C” items. Therefore, “B” items are intergroup items.”C” items are marginally important.

ABC Values in Inventory Stock Management

The Pareto Analysis, which is more commonly known as the 80/20 rule, can be put to use with the ABC analysis for inventory stock management. Under this rule, in terms of consumption, 80 percent of the value of inventory would be held in about 20 per cent of the items – category A. By using this principle, categories B and C would make up the remaining 80 per cent of the items, perhaps B with 30 per cent and C with 50 percent.

However, in terms of their consumption value B and C would make up on 20 per cent of the value combined, for example B totalling 15% of value and C perhaps 5%. The percentages will vary based on a distributor’s unique inventory stock control needs.

This means that ABC analysis conforms with the Pareto principle, which states that items that account for a large proportion of the overall value are small in number and that items with a low overall value are high in number. The proportions of the ABC values, both in terms of their consumption value and their number of items, are not set in stone, so long as they add up to 100 percent.

Advantages and Disadvantages

A business may have better control on expensive items in which large investment is required. Furthermore, cycle counting, which is an indicator of stock replenishment, can be effectively used after completing the grouping, which makes it easier to manage and see trends, such as opportunities and make better informed decisions in business. By this categorisation method it may ensure a reduction in storage expenses because your analysis will affect and cater for forward planning if you know how your inventory is categorised. However, like with any analysis there are certain disadvantages that need to be taken into account. The ABC method generally cannot be employed where products cannot be standardised. Moreover, classification is done purely on the basis of monetary value and other factors are ignored.

A good system to codify the products should be used in order to perform the ABC analysis to use the analysis to its full potential.

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Melanie - Unleashed Software

Article by Melanie Chan in collaboration with our team of Unleashed Software inventory and business specialists. Melanie has been writing about inventory management for the past three years. When not writing about inventory management, you can find her eating her way through Auckland.

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