Performance an ABC analysis is an effective way for a business to determine the value of its
products. It’s a simple process that helps manage large amounts of inventory, and how many
resources should be allocated to each classification in order to yield the most profit.
ABC (Always Better Control) analysis is one of the most commonly used inventory management
methods. ABC analysis group’s items into three categories (A, B, and C) based on their level of
value within a business.
Classifying inventory with ABC analysis helps businesses prioritize their inventory, optimize
operations, and make clear decisions. Coming up, we’ll explore ABC analysis in-depth, explain
how to use it, and help you decide if it’s right for your business.
- To perform an ABC analysis for your business, follow these three steps:
1. Classify Your Inventory
The way you classify your inventory depends on what kind of business you’re running and your
company’s objectives. Your classifications should align with the type of inventory you hold and
how your business is run. Any metric you use should measure your inventory’s consumption
value for a given period. Standard metrics are total sales, gross margin, purchasing costs, and
holding costs. After you calculate the percentages for each item, place them in your A, B, and C
categories.
2. Create Rules for Inventory Classes
For your different inventory categories (A, B, C), create a set of rules or actions for how your
classifications should function. For example, class A inventory should never have a stock out or
have a certain turnover threshold. Then for C-class items, it’s fine if you have stakeouts, but you
don’t want to write off any spoiled inventory. You could rely on an inventory management
solution to gain rapid insight into how your team performs relative to these standards.
3. Monitor and Look for Opportunities to Change Classes
As you grow and add items to your inventory, your classification mix will change. If you
continue to monitor your analyses, you’ll start to notice patterns and be able to forecast which
inventory is most vital for you to manage and which are least important. By always having the
right inventory mix, your operations will run more efficiently, and cash flow nightmares will
eventually be a thing of the past.
Once all inventory has been reviewed and categorized, the next step is to implement your ABC
analysis. The following section shares some recommended ways to make the most of this
approach in your business.
The Pareto Principle & ABC analysis:
ABC analysis sorts inventory into three main buckets:
A item: This is your inventory with the highest annual consumption value. It should be your
highest priority and rarely, if ever, a stock out.
B items: Inventory that sells regularly but not nearly as much as A items. Often inventory that
costs more to hold than A items.
C items: This is the rest of your inventory that doesn’t sell much, has the lowest inventory
value, and makes up the bulk of your inventory cost.
Inventory categorization is essential with physical products because it protects your profit
margins and prevents write-offs and losses for spoiled inventory. It is also the first step in
reducing obsolete inventory, supply chain optimization, increasing prices, and forecasting demand.
ABC inventory analysis is based on the Pareto Principle, meaning it’s often the case that about
20% of a company’s inventory accounts for 80% of its value. This insight enables leaders to
make more operationally informed decisions.
The way Pareto’s Principal factors into ABC analysis is how it is used to prioritize and sort
specific inventory over others. ABC analysis brings simplicity to inventory analysis by putting
all of your stock into three buckets, enabling you to make more strategic decisions.
A cycle count is the process of counting specific items within your inventory on scheduled dates.
Some companies use cycle counting to create count lists for various sections of their warehouse
every month. Still, the frequency can vary depending on how often stock levels fluctuate.
ABC analysis lets you customize your cycle counting process, which optimizes inventory control
for your unique needs. For example, you might decide that your A items should be counted every
month, while B items only need to be counted every quarter.
When ABC analysis is applied to cycle counting, it saves precious time and labor since you only
count inventory categorized by class. Otherwise, you’re stuck counting all inventory items at the
same time intervals.
Best practices for implementing ABC analysis:
ABC analysis works best when applied consistently and reviewed regularly. Here are some best
practices when implementing ABC analysis in your business:
Keep inventory classifications simple
With the goal of streamlining your inventory management, the classifications of your ABC
analysis are best kept simple. It should be easy for your teams to know which products belong to
specific classes immediately. For example, common classification methods are according to the
product's price or sales frequency.
Set labor levels according to classification
Each classification should be assigned its labor level or the number of hours dedicated to
working on the particular inventory class. Naturally, the more value or impact the class has on
the business, the higher labor levels should be allotted to the classification.
Review each class individually
Every classification should be measured against its own rules set by the initial ABC analysis.
This includes a different set of KPIs, performance reviews, and approach to reordering or selling
any overstock.
Revisit original classifications
The initial ABC analysis took into account the types of products and business status at that point.
As inventory and markets change, it’s important to revisit the existing classifications and
reclassify, if necessary. Consider consumer trends, new industry competitors, and changes in
sales per class and product.
Utilize software tools and data
Inventory software can help track all the changes in product turnover and sales. With an
established set of rules and actions, you can easily use an inventory management system to
automatically track and create reports to highlight any key areas of improvement.
THANK YOU
