Introduction to ABC analysis :
In materials management, the ABC analysis (or Selective Inventory Control) is an inventory
categorization technique. ABC analysis divides an inventory into three
categories- “A items” with very tight control and accurate records, “B
items” with less tightly controlled and good records, and “C items” with
the simplest controls possible and minimal records.
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.
The ABC analysis suggests that inventories of an organization are not of equal value. Thus, the inventory is grouped into three categories (A, B, and C) in order of their estimated importance.
‘A’ items are very important for an organization. Because of the high
value of these ‘A’ items, frequent value analysis is required. In
addition to that, an organization needs to choose an appropriate order
pattern (e.g. ‘Just- in- time’) to avoid excess capacity. ‘B’ items are
important, but of course less important than ‘A’ items and more
important than ‘C’ items. Therefore ‘B’ items are inter group items. ‘C’
items are marginally important.
 

ABC analysis Chart
Fig. ABC analysis Chart
Various names of ABC analysis Or Similar Techniques.
  1. ABC Analysis
  2. Pereto Analysis 
  3. 80/20 Rules
  4. Vital Few,Trivel manys
  5. VED Analysis
The ABC analysis
The ABC approach states that a company should rate items from A to C, basing its ratings on the following rules:
  • A-items are goods which annual consumption value is the highest; the top 70-80% of the annual consumption value of the company typically accounts for only 10-20% of total inventory items.

  • B-items are the inter class items, with a medium consumption value; those 15-25% of annual consumption value typically accounts for 30% of total inventory items.

  • C-items are, on the contrary, items with the lowest consumption value; the lower 5% of the annual consumption value typically accounts for 50% of total inventory items.
table gives value of ABC parameter

 ABC analysis Calculation :
The annual consumption value is calculated with the formula:
(Annual demand) x (item cost per unit)
Through this categorization, the supply manager can identify inventory hot spots, and separate them from the rest of the items, especially those that are numerous but not that profitable.

Advantages of ABC Classification

  • This kind of categorization of inventory helps one manage the entire
    volume and assign relative priority to the right category. For Example A
    Class items are the high value items. Hence one is able to monitor the
    inventory of this category closely to ensure the inventory level is
    maintained at optimum levels for any excess inventory can have huge
    adverse impact in terms of overall value.
  • A Category Items: Helps one identify these stocks as
    high value items and ensure tight control in terms of process control,
    physical security as well as audit frequency.
  • It helps the managers and inventory planners to maintain
    accurate records and draw management’s attention to the issue on hand to
    facilitate instant decision-making.
  • B Category Items: These can be given second priority
    with lesser frequency of review and less tightly controls with adequate
    documentation, audit controls in place.
  • C Category Items: Can be managed with basic and simple records. Inventory quantities can be larger with very few periodic reviews. 

Disadvantages

  • Inventory Classification does not reflect the frequency of movement of SKU and hence can mislead controllers.
  • B & C Categories can often get neglected and pile in huge
    stocks or susceptible to loss, pilferage, slackness in record control
    etc.
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