What Is ABC Analysis?

ABC analysis is an approach that allows you to assign classes to inventory items based on that items’ consumption value. If you don’t know what that is, consumption value is the total value of an item consumed over a specified time period, which could be a year or month. This approach is based on the Pareto principle (the marketers will know that one) to help manage what’s important and this is how it’s done;

• A Items – These refer to goods where annual consumption value is at the highest. Applying what is called the Pareto principle (also referred to as the 80/20 rule where 80 percent of the output is determined by 20 percent of the input), they comprise a relatively small number of items but have a relatively high consumption value. This is a logical analysis and control of this class can be extremely beneficial as these items have the greatest potential to reduce costs or losses.
• B Items – This is going to be interclass items. B consumption values are lower than A items but higher than C items. A key point of having this interclass group is to watch items close to A item and C item classes that would alter their stock management policies if they edge closer to a higher class or lower class. Stock management is a cost, so there needs to be a balance between controls to protect the asset class and risk of loss, or the cost of analysis and the potential value returned by reducing class costs. The scope of this class and the inventory management procedures are determined by the estimated cost-benefit of class cost reduction and loss control processes.
• C Items – These have the lowest consumption value. This class has a relatively high proportion of the total number of lines but often has low consumption values. In most cases, it’s not cost-effective to use tight inventory controls, this is due to the value and risk associated to the items.

Since no two businesses are completely alike, the threshold that defines the upper and lower limits of each class are not definable, nor would they be fixed over time or across multiple locations. You wouldn’t have the same “risk” at every location. A business will likely have different risk between multiple locations.

Just to give you an example, think about a location that has a high-crime rate and most of the inventory stored there is A Items. This is why you want your management accountant carrying out risk and stock management cost-benefit analysis by location to deliver the optimal overall cost-benefit balance and to set the appropriate ABC ranges.

What Benefits Does ABC Analysis Provide?

• It gives you better control over your high-value inventory items while helping reduce losses and costs.
• Gives you more efficient use of stock management resources.
• Relatively low value of B or C class holdings can allow a business to hold bigger buffer stocks to reduce stock outs.
• Fewer stock outs are going to result in better production efficiency.
• Fewer stock outs and improved production efficiency resulting in more reliable cycles, enhancing customer experience.

Questions For Implementing ABC Inventory Management

• Is there reliable and accessible cost and demand information by item?
• Will your inventory management systems and processes facilitate efficient operations with the ABC concept?
• Have the costs and benefits of implementing and operating ABC been quantified?
• Are you properly planning for implementing ABC?

If you’re going to leverage the ABC concept and implement it into your business, it must be carefully planned for. Make sure you’re asking the right questions, make sure you understand the benefits for using this ABC system.