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ABC Analysis: How to Manage and Control Inventory | Company Vakil

ABC analysis method, also known as Selective Inventory Control (SIC), is an inventory control mechanism which is used to control the inventory . In short, it is a mechanism which is used to categorize inventory into three main category namely A, B and C where A is the most valuable and complex B somewhere in between most valuable and least valuable and C is the least important and quite simple. The ABC analysis method is especially fruitful to identify the significance of each item and their impact on the overall inventory finance. It is also used to detect the necessary management control for each different stock. Due to its high proficiency and usability in business sector, it has become a very important tool in the industry.

 

What does the ABC symbol mean?

The A, B and C units refer to items and each letter is used to denote the significance of the category the item falls under. A is the most valuable and C is the least and B remains somewhere in between.

ITEM A:

In the ABC method of inventory control, goods that has the highest value in regards to annual consumption falls under the A category. An interesting thing found is that a total of about 10% to 20% of the items covers the yearly consumption of the top 70% to 80% of the value. Therefore, it is very important to prioritize the products accordingly.

ITEM B:

The items with moderate consumption value falls under the category of B. About 15% to 20% of the annual consumption value is accounted by the 30% of the total inventory.

 ITEM C:

The items with the lowest consumption value accounting for less than 5% of the annual consumption but covers about 50% of the total quantity of items fall under the category of C. The quantity of the items may be high but the overall consumption value is significantly poor.

It should be noted that the consumption value is determined by the following formula:

(Annual demand of the item) × (item cost each unit)

 

The policies regulating the ABC analysis method

The aim of using the ABC analysis method is to understand the imbalance of sales of different items. It means that, not all items are of equal value and that each item has to be given an appropriate amount of significance depending on their demand. The regulations policing these categories are briefed as follows:

ITEM A:

  • These items are given the most strict inventory control
  • Storage is done in highly secured places
  • Forecast for item sales is quite good
  • These items are subjected to frequent re-orders on either weekly or even daily basis
  • These items are deemed as priority items
  • It is made sure that these items are not run out of stock
  • Availability of the items are assured

 

ITEM B:

  • These items fall between A and C in terms of significance
  • These items are not as important as those of A
  • These items are not as insignificant as those of C
  • These items have a potential to be categorized as A if needed
  • These items have a potential to be categorized as C in the situation is unfavorable

 

ITEM C:

  • These items are manufactured less
  • Only one item of each kind is kept at hand
  • More items of the same kind is manufactured only after order
  • It does not matter if the items are out of stock since the items are less in demand but more in production cost
  • The main area of concern for these items is not how many items are to be kept in the inventory but if these items are needed in the first place or not

 

Application of ABC Analysis

  • This method is significantly used in stock checking, supply chain management, inventory system and so on.
  • It is also applied as a cycle counting system.
  • If a company want to decrease their working capital and diminish the carrying cost, ABC analysis is the most suitable method.
  • Analysis of items aware the manager and they can decide which products are in demand and which products are out of demand
  • Managers can easily decide which items deserve a significant place in the inventory
  • ABC method helps to properly utilize the full capital instead of making the business stagnant
  • ABC method helps the companies understand the value of their assets and stock and thus they can plan accordingly ,which is beneficial for their over-all business
  • The process ensures the items in demand are ready in stock; thus, it is time-efficient to meet the demands with reduced manufacture costs
  • Categorizing items based on demand and supply is not only beneficial to the wholesalers but also distributors
  • Quality is maintained without any wastage.

 

Advantages of the Application of ABC Method

  • The method is very beneficial to the companies who have invested huge amounts of capital on the expensive items in order to control them
  • A fruitful way to keep track all the items present in the company inventory
  • It reduces the unnecessary extra expenses on staff and ensures the maximum maintenance of stock irrespective of time
  • This method ensures that the stock turnover ratio is looked after through a simple and systematic control of the stock at a higher level
  • The expenses for storage is lowered with this method
  • These method also ensures that lowest demand items are maintained without compromising the maintenance of the higher valued goods

Disadvantages of the Application of ABC Method

  • In order for the ABC analysis method to work and provide fruitful results, proper standardization of the place in the store for the materials is a must
  • The analysis can only work if there is a significant system of coding of products present in the operation already
  • Since only the financial value of the items are taken into consideration for the analysis to work, sometimes the system may ignore the other factors which are valuable for the business. Therefore, this is a vital distinction which is to be looked upon.

Conclusion:

The ABC analysis method is a very important tool in the modern business sector. It differentiates between items that need either prime attention or minimum attention. The method is very helpful in management of time and ensures the supply of the high-demand goods right on time. Because the items are neatly categorized, inventory maintenance becomes very easy and coherent. Focusing and prioritizing  right items is very important for any successful business. Best results are attained only when the capital is fully utilized to its potential without wasting  its energy and time.

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