Tossing around the phrase “ABC Analysis” is prevalent in inventory management discussions. ABC Analysis is an inventory planning and control approach to inventory management. Understanding ABC analysis provides a method for managing inventory costs and revenue.
What is ABC analysis?
ABC analysis is an inventory categorization process. This method suggests not all stock is created equal. By categorizing stock inventory into A, B or C items, your company manages the cost and revenue associated with inventory.
Items consist of stock representing approximately 80% of inventory value. However, this same stock represents only 15% – 20% of inventory count. They are your most important items. In order to optimize A items, accurate records and tight controls are paramount. The priority of A items necessitates their availability.
B items constitute 30% – 35% of inventory count, but only represent about 15% – 20% of inventory value. B items require periodic management and consistent record keeping.
C items form 50% of inventory stock but contribute only 5% to inventory value. Tracking C items require basic record keeping and simple inventory control measures.
Remember, the percentages may vary from company to company, as long as they add up to 100% and follow a similar differentiation.
The benefits of ABC analysis
ABC analysis provides insight into inventory performance. It also allows you to focus on decreasing inventory costs while increasing revenue through stock management.
By monitoring inventory performance, you optimize inventory revenue by assigning needed resources to reduce inventory costs and increase turnover.
You can stay on top of market fluctuations encountered with B items, by recategorizing according to need. High priority items become A while lower priority items are relegated to C. The ability to move items from one level to the next as customer needs change cuts down on inventory management expense.
The challenges of ABC analysis
ABC analysis isn’t always an easy tool to utilize. Understanding your items and how they’re categorized isn’t a one time process. You need to stay abreast of market trends and adjust stock categorization according to market demands.
Another challenge that occurs from incorporating ABC analysis into your inventory management is aligning the tool with your cost systems. ABC analysis doesn’t comply with all standard cost systems, like GAAP. ABC analysis might require you to work with an internal costing system, one for your ABC analysis and one complying with traditional accounting principles.
Despite its challenges, ABC analysis helps inventory managers and company owners manage inventory profitability and turnover. Understanding how your stock works and what items move faster than others allows you to make educated decisions on how to stock inventory while improving the efficiency of your operations.