ABC Analysis - An approach to Inventory Control

 

Inventory control through ABC analysis

Introduction:

ABC Analysis is a form of selective inventory control technique. This process will help to control over materials by classifying them into THREE categories which are A-B-C categories. This approach helps to classify the inventory items based on their consumption value. People often get confused about the ABC classifications as this is based on the unit price. But, please note that this is fully based on the consumption value of items over a certain period of time, say One year. This inventory management approach helps to converge the focus of the management to put maximum efforts to control the inventory.

This is based on the Pareto principle which helps to identify the area where to focus more and which will give more desired results.

A-B-C categorization:

ABC categorization

If all items, which are in store stock representing the entire inventory, are analysed in terms of annual consumption of each inr value it will be observed that not more than 10% for usually 5% of these items accounts for about 80% of the total annual consumption cost,  about 20% off items causing 15% of the annual consumption cost and remaining 70% of the items will cover only 5% of the annual consumption cost. the small number of high consumption value items are called A category items,  the medium  consumption value items are called B-class items  and the large number of items annual consumption value is very low are classified as C-class items.It is very important to understand that ABC analysis does not depend on the unit cost of the item,  but only on its total annual consumption value.  It is a common mistake to consider the unit price as one of the criteria for ABC analysis,  but this is not true. Again it does not depend on the importance of the items. All items are necessary and therefore important that is why they are held in inventory and without a single item, which is required in the bill of material,  the product cannot be made. if anyone entertains the notion that “A class items are important and C class items are not so important” the person would certainly be wrong.  For example, consider and automobile industry where the average cost of a nut and bolt is around 20 paisa.  company uses 20 lacs of pieces a year And the annual consumption value is 4 lakhs.Though, unit price wise it is a very small item yet it could be an a class item because the annual consumption value of this item determines the criteria of its classification and not its unit cost.

Benefits of ABC analysis:

The purpose of ABC analysis should now be quite clear.  to separate the predominant few ( from the point of view of annual consumption value)  from the vast majority of items was annual consumption value is very low.  the reason why this is done is simple to explain. without a systematic ABC analysis,  perhaps moral is equal attention will be paid to all items,  with the result that the control will be unnecessarily too costly and will be too defused to remain efficient. ABC analysis gives rise to a selective inventory control in which maximum attention attention can be given to A- class items,  a fair amount to B class items,  while the attention necessary for C class items can be reduced to routine procedures.

 

ABC contribution

1. Always Better Control on the overall inventory and focused approach, which improves the material availability, reduce the production loss and cost.
2. Loss time reduction as less materials shortages, which in turn, improves the cycle time and customer satisfaction.
3. Efficient use of resources. For example, during cycle counting, more resources to be deployed for A class items than B class or C class items. This reduces the time and money with more accuracy for High value spent items.
4. Focused approach towards A class items to reduce Lead time, cost reduction, import substitution and more strategic approach.

Graphical representation:

ABC Graph

In the above picture I have tried to explain that it will be obvious that the time effort and expenses in controlling A-class items will give returns which are very much higher than those available from controlling C-class items.

The way of determining the Criterion for an ABC analysis is to find out the consumption records of issuance from the stores with annual consumption value of each item in rupees then certain monetary limits are set for each of the categories depending upon the size of undertaking the number of items and the total annual consumption. After working out the annual consumption value for all the items arrange them in descending order of total value of the consumption. against each value also indicate the cumulative value of consumption and the percentage of this value to the total annual value of consumption for all items.  Draw cut off limit at the percentage figure in the last column which is considered by the management as the limit for a class items, let's say 80%.  all items above this limit will be A-class items,  items lying between 80% to 95% are B-class items  and the rest are C-class items.

 

Control Measures:

The below tabular chart will provide you with better inventory controlling measures for these A-B-C categories of items.

A	B	C
Tight control on stock levels	Moderate control	Lose control
Only exact requirement to be procured, more than one source is preferred, centralized purchasing for better spend control	More or less exact requirement, reduce lead time	On estimated usage
Individual issuance during against production orders and in terms of charging out cost to consumption	Individual posting during material issuance	Collective posting or preferably none at all (Bulk or Backflush)
Very low buffer stock or none at all	Exact requirement to be worked out	large safety stock can be defined
Regular expediting and follow up	some follow up	No need to indulge time in follow up
Very strict consumption control by laying down norms and standards	Consumption control is highly desirable	Though consumption control is desirable, but no need to indulge much time
Material planning should be very accurate specially in regards to forecast	Past consumption may be taken as basis	Rough estimates would be satisfactory
Concerted efforts in cost reduction through modern techniques like value analysis. Efforts should be more on import substitution.	moderate efforts would be sufficient	An annual review
Monthly or quarterly cycle counting with strict adherence	Quarterly cycle counting is sufficient	Annual inventory counting is sufficient

Conclusion:

Purchasing policy and procedure should be so formulated that,  for A class items,  maximum attention is devoted to pre-designed and pre-purchase value analysis, market research,  source development and follow up. placing of orders for stores items to be based on the A-B-C principle. Generally, class items are ordered more frequently and in small quantities,  while C-class items are ordered just once or twice a year to obtain the entire year’s requirement.