ABC analysis in Material Management

In materials management, ABC analysis is an inventory categorization technique. ABC analysis divides an inventory into three categories, “A items” with very tight control and accurate records, “B items” with less tightly controlled and good records, and “C items” with the simplest controls possible and minimal records.

The ABC analysis provides a mechanism for identifying items that will have a significant impact on overall inventory cost, while also providing a mechanism for identifying different categories of stock that will require different management and controls.

The ABC analysis suggests that inventories of an organization are not of equal value. Thus, the inventory is grouped into three categories (A, B, and C) in order of their estimated importance.

‘A’ items are very important for an organization. Because of the high value of these ‘A’ items, frequent value analysis is required. In addition to that, an organization needs to choose an appropriate order pattern (e.g. ‘just-in-time’) to avoid excess capacity. ‘B’ items are important, but of course less important than ‘A’ items and more important than ‘C’ items. Therefore, ‘B’ items are intergroup items. ‘C’ items are marginally important.

The ABC concept is based on Pareto’s law.[9] If too much inventory is kept, the ABC analysis can be performed on a sample. After obtaining the random sample, the following steps are carried out for the ABC analysis.

• Step 1: Compute the annual usage value for every item in the sample by multiplying the annual requirements by the cost per unit.
• Step 2: Arrange the items in descending order of the usage value calculated above.
• Step 3: Make a cumulative total of the number of items and the usage value.
• Step 4: Convert the cumulative total of the number of items and usage values into a percentage of their grand totals.
• Step 5: Draw a graph connecting cumulative % items and cumulative % usage value. The graph is divided approximately into three segments, where the curve sharply changes its shape. This indicates the three segments A, B and C.

Advantages

• The ABC method makes sure that the stock turnover ratio is maintained at a comparatively higher level through a systematic control of inventories
• There is provision to have enough C category stocks to be maintained without compromising on the more important items
• This method helps businesses to maintain control over the costly items which have large amounts of capital invested in them
• The storage expenses are cut down considerably with this tool
• It provides a method to the madness of keeping track of all the inventory. Not only does it reduce unnecessary staff expenses but more importantly it ensures optimum levels of stock is maintained at all times

Disadvantages

• It requires a good system of coding of materials already in operation for this analysis to work
• For this method to work and render successful results, there must be proper standardization in place for materials in the store
• Since this analysis takes into consideration the monetary value of the items, it ignores other factors that may be more important for your business. Hence, this distinction is vital

Policies

Item A:

• These are subjected to strict inventory control and are given highly secured areas in terms of storage
• These goods have a better forecast for sales
• These are also the items that require frequent reorders on a daily or a weekly basis
• They are kept as a priority item and efforts are made to avoid unavailability or stock-out of these items

Item B:

• These items are not as important as items under section A or as trivial as items categorized under C
• The important thing to note is that since these items lie in between A and C, they are monitored for potential inclusion towards category A or in a contrary situation towards category C

Item C:

• These items are manufactured less often and follow the policy of having only one of its items, on hand or in some cases they are reordered when a purchase is actually made
• Since these are low demand goods with a comparatively higher risk of cost in terms of excessive inventory, it is an ideal situation for these items to stock-out after each purchase
• The questions managers find themselves dealing with when it comes to items in category C is not how many units to keep in stock but rather whether it is even needed to have to these items in store at all