ABC Analysis – inventory | analysis | annual usage
ABC Analysis
Not all inventory is the same. Therefore, you don’t manage all inventory in the same manner. All inventory is important, but some inventory is more important than others.
So, how do you distinguish between the important inventory and the not-so-important inventory, and how to manage it differently? A-B-C inventory analysis is a good approach for this task. It’s based on the Pareto Principle, You can apply the Pareto Principle to just about anything, wealth distribution, inventory value, sales by product, revenue by customer, just about any aspect of the business.
In general, you will find that 80% of the value is created by only 20% of those items you are analyzing. The Pareto Principle is often called the 80/20 rule. When you apply the Pareto Principle to inventory, you are conducting an A-B-C analysis.
For this analysis, you use a measurement called total dollar usage. The formula for this is total dollar usage equals volume, how much you use, times unit cost, the item’s financial value. Once you calculate the total dollar usage for each item, you can rank the items from high to low value. Remember, this figure is a multiplication of the two inputs.
The first item on your list might be a high-cost item that is used only a few times during the year. Or it could be a lower-cost item with a very high volume. With this rank-ordered list, you normally can see two obvious breakpoints, a few items at the top with large cost usage figures, and many items at the bottom with very small cost usage figures.
You can now divide your items into categories A, B, and C. Each category will be managed differently. Let’s break down these categories. Category A items are the few items at the top of the list with a high annual dollar usage. They need very close control by everyone involved with their management.
These items might be inventoried daily, or even continuously. And you don’t wanna run out of this inventory, but you also cannot afford to hold unneeded inventory. Good examples of this are the engines and transmissions needed for an automobile plant. Category C items are the many items at the bottom of the list.
They each have a small annual dollar usage, and collectively, they are usually only 5-15% of the total value. These items do not need close monitoring, and often they are managed by automated computer systems. Because many of them have a low unit cost, you can afford to hold additional inventory. Examples include bolts and nuts, and hardware for an assembly line. Category B items are those in-between. And they usually comprise about 20% of the items on your list. Depending upon your business, you design special inventory management methods for these medium-range items.
Inventory in your company varies by dollar value, annual usage, and importance to the process. With A-B-C analysis, you now have a valuable tool to help you manage inventory differently.