Inventory management is of the utmost importance to any company as unhealthy inventory stock levels can quickly spell disaster regarding the ability to supply and the bottom line. Gaining inventory control can be difficult at the best of times, however there are some tried and true methods which can make the road to inventory control that much more tolerable.
The ABC method is one such method that is not dissimilar to Pareto analysis, the well-known ’80/20’ rule, where typically 20% of items hold 80% of the overall value. ABC analysis involves allocating correct proportions of the storage space and inventory value to certain inventory stock items based upon their frequency of sale and individual values. The actual assigned values are largely unique to each company however they still follow a general pattern.
Category A is assigned to the inventory stock that is the highest in inventory value (approximately 80% of the total inventory cost). This category should comprise a mere 15-20% of the total inventory amount, with frequent stock take analyses to ensure reordering happens appropriately. If these high-value inventory items were allowed to exceed the approximate level at which they are required, they face risk of obsolescence or expiration which carry a significant cost. Likewise, any capital tied up in them cannot be used elsewhere resulting in lost opportunity costs.
The inventory stock items in Category B comprise approximately 30-35% of the total inventory amount yet only carry approximately 15% of the inventory value. These items do not need to be reviewed quite as much as Category A and any erroneous stocking of Category B items does not result in quite as much potential risk as that noted for Category A.
Category C encompasses the remainder of the inventory stock which should represent approximately 50% of the stock with a mere 5% of the total value. These items do not need to be as closely monitored and replenished.
Conducting an ABC Analysis
Identify what item is to be analysed and why. This could be to reduce costs associated with inventory stock or to increase sales by ensuring the correct products are available at the correct times.
The next step is to determine how much the stock is worth, be it the initial cost of procuring it or the weighted cost, which also includes carrying and storage costs.
It is then important to ask yourself what impact each item has on the company’s inventory and sort it in the order of most to least.
The next thing to do is calculate the cumulative cost of inventory stock items to ascertain what percentage of the annual inventory spend they consume.
Order in buy classes
With the data from steps 2-4, it is possible to organise the inventory into buy classes according to ABC groupings.
Analysis of classes
The final step is important. This is to analyse the buy classes and ensure they are appropriate. Do not be afraid of making tweaks and adjustments that will benefit the company and result in significant savings in terms of reduced costs and higher turnover of inventory.
Difficulties with ABC Analysis
There are some difficulties of ABC analysis to be aware of which, although not detrimental, can be tricky to work through. Classification of the categories can be difficult as the value of products may change. This is largely due to availability, affordability and perception of your own as well as your competitor’s products, which can now be altered relatively quickly through social media and advertising. The initial set up and continual analysis of Category A products can be very time-consuming, which carries a certain cost too. It is however, extremely beneficial to embark on the road of ABC analysis to find a better and more cost-effective way of keeping inventory management in control and reducing associated inventory management costs.