ABC Analysis

ABC method of inventory control involves a system that controls inventory and is used for materials and throughout the distribution management. It is also known as selective inventory control or SIC.

ABC Method of Inventory Control

It has become an indispensable part of a business and the ABC analysis is widely used for unfinished good, manufactured products, spare parts, components, finished items and assembly items.

This method of management divides the items into three categories A, B and C; where A is the most important item and C the least valuable.

Need for prioritizing inventory

Item A:

In the ABC model of inventory control, items categorized under A are goods that register the highest value in terms of annual consumption. It is interesting to note that the top 70 to 80 percent of the yearly consumption value of the company comes from only about 10 to 20 percent of the total inventory items. Hence, it is crucial to prioritize these items.

Item B:

These are items that have a medium consumption value. These amount to about 30 percent of the total inventory in a company which accounts for about 15 to 20 percent of annual consumption value.

Item C:

The items placed in this category have the lowest consumption value and account for less than 5 percent of the annual consumption value that comes from about 50 percent of the total inventory items.

Note: The annual consumption value is calculated by the formula:

(Annual demand) × (item cost per unit)

Use of ABC Analysis

The ABC analysis is widely used in supply chain management and stock checking and inventory system and is implemented as a cycle counting system.  It is most important for companies that seek to bring down their working capital and carrying costs.

This done by analyzing the inventory that is in excess stock and those that are obsolete by making way for items that are readily sold. This helps avoid keeping the working capital available for use rather than keeping it tied up in unhealthy inventory.

When a company is better able to check its stock and maintain control over the high-value goods it helps them to keep track of the value of the assets that are being held at a time. It also brings order to the reordering process and ensures that those items are in stock to meet the demands.

The items that fall under the C category are those that slow-moving and need not be re-ordered with the same frequency as item A or item B. When you put the goods into these three categories, it is helpful for both the wholesalers and the distributors to identify the items that need to be stocked and those that can be replaced.

Advantages of implementing the ABC method of inventory control

(i) This method helps businesses to maintain control over the costly items which have large amounts of capital invested in them

(ii) It provides a method to the madness of keeping track of all the inventory. Not only does it reduce unnecessary staff expenses but more importantly it ensures optimum levels of stock is maintained at all times

(iii) The ABC method makes sure that the stock turnover ratio is maintained at a comparatively higher level through a systematic control of inventories

(iv) The storage expenses are cut down considerably with this tool

(v) There is provision to have enough C category stocks to be maintained without compromising on the more important items.

Disadvantages of using the ABC analysis

(i) For this method to work and render successful results, there must be proper standardization in place for materials in the store

(ii) It requires a good system of coding of materials already in operation for this analysis to work

(iii) Since this analysis takes into consideration the monetary value of the items, it ignores other factors that may be more important for your business. Hence, this distinction is vital

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