Inventory items are not of equal importance in terms of
dollars involved, profit potential, sales or usage volume, or stockout penalties Example : Producer of Electrical Equipment Inventory carried includes generators, coils of wire, and miscellaneous nuts and bolts among other items in stock Unrealistic to devote equal attention to each of these items Instead, a more reasonable approach would be to allocate control efforts according to the relative importance of various items in inventory A-B-C approach classifies inventory items according to some measure of importance, usually dollar usage (i.e. dollar value per unit multiplied by annual usage rate), and allocating control efforts accordingly I nventory Classification System ABC Analysis divides on-hand inventory into three classifications on the basis of annual dollar value. It is an inventory application of the Pareto principle which states that there are a critical few and trivial man. Idea is to establish inventory policies that focus resources on the few critical inventory parts and not the many trivial ones. It is not realistic to monitor inexpensive items with the same intensity as very expensive items. I nventory Classification System ABC Classification Annual dollar volume = annual demand x cost per unit Dollar volume is a measure of importance; an item low in cost but high in volume can be more important than a high-cost item with low volume. Typically three (3) classes of items are used: A (very important), B (moderately important), and C (least important) The actual number of categories may vary from organization to organization, depending on the extent to which a firm wants to differentiate control efforts. I nventory Classification System ABC Classification Class A items generally account for about only 15% to 20% of the number of items in inventory but represent 70% to 80% of the total dollar usage Class C items may represent only 5% to 10% of the annual dollar volume but about 55% to 60% of the total inventory items Class B items are those inventory items with medium annual dollar volume, about 15% to 20% of the total value representing about 30% of the the number of inventory items Percentages vary from firm to firm, but in most instances a relatively small number of items will account for a large share of the value or cost associated with an inventory I nventory Classification System ABC Classification Class A items should receive a close attention through frequent reviews of amounts on hand and control over withdrawals. Class C items should receive only loose control (two-bin system, bulk orders). Class B items should have controls that lie between A & C. Class C items are not necessarily unimportant; incurring a stock out of C items such as the nuts and bolts used to assemble manufactured goods can result in a costly shutdown of an assembly line (due to low annual dollar volume, larger orders or ordering in advance will help without incurring much additional cost). Steps To Solve An A-b-c Problems Find out the unit cost and the usage of each material over a given period. Multiply the unit cost by the estimated annual usage to obtain the net value. List out all the items and arrange them in the descending value. (Annual Value) Accumulate value and add up number of items and calculate percentage on total inventory in value and in number. Draw a curve of percentage items and percentage value. Mark off from the curve the rational limits of A, B and C categories. Inventory Classification System Example ABC Calculation (1) (2) (3) (4) (5) (6) (7) ITEM STOCK NUMBER PERCENT OF NUMBER OF ITEMS STOCKED ANNUAL VOLUME (UNITS) x UNIT COST = ANNUAL DOLLAR VOLUME PERCENT OF ANNUAL DOLLAR VOLUME CLASS 1 20% 1,000 $ 90.00 $ 90,000 38.8% A 2 500 154.00 77,000 33.2% A 3 1,550 17.00 26,350 11.3% B 4 30% 350 42.86 15,001 6.4% B 5 1,000 12.50 12,500 5.4% B 6 600 $ 14.17 $ 8,502 3.7% C 7 2,000 .60 1,200 .5% C 8 50% 100 8.50 850 .4% C 9 1,200 .42 504 .2% C 10 250 .60 150 .1% C 8,550 $232,057 100.0% Inventory Classification System
A Items B Items | | | | | | | | | | 10 20 30 40 50 60 70 80 90 100 P e r c e n t a g e
o f
a n n u a l
d o l l a r
u s a g e
80 70 60 50 40 30 20 10 0 Percentage of inventory items C Items Some of the benefits of using ABC classification Manage the goods in the inventory in a proper manner You get to have a thorough knowledge about the amount and quantity of goods that might be needed You will be able to prioritize the importance of goods that are need in the production process. You will be able to identify the items that make a significant impact to the whole of the production process You will understand the true nature of the quality and quantity of the goods used in the production process.