Managing thousands of stock items from a range of suppliers to a large customer base is never easy. Therefore implementing a system that prioritises the management of particular stock based on its importance to the business becomes crucial. One such way to do it is to use a model called the ABC analysis.
What is the ABC Analysis?
The Pareto principle states that for many outcomes, roughly 80% of consequences come from 20% of causes. The ABC analysis applies this to your stock: 20% of your items will give you 80% of your sales.
The purpose of the ABC analysis is to allow you to classify your inventory and place an appropriate amount of focus on the items that produce the most turnover.
How to Perform an ABC Analysis?
Essentially performing an ABC analysis is all about classifying your inventory. The way you will do that will depend on the kind of business you’re running and your objectives. As a general guide however, here is how many business’ perform it:
Step 1: You need to determine each items inventory value. You do this by multiplying the price by the consumption volume over a given period.
Inventory Value = Item Cost x Consumption Volume.
Step 2: Sort all items according to their inventory value from highest to lowest.
Step 3: Calculate how much each item contributes to the overall value as a percentage by dividing the items inventory value, by the total inventory values.
Item % of Total Inventory Value = Item’s Inventory Value / Total Inventory Values
Step 4: Group items according to their contribution to the overall inventory value.
Benefits of ABC Analysis
As the table above shows, once you have analysed your stock and assigned each item a category, you can use this to increase efficiencies around stock control and management.
For example, as Type A items are the most business-critical, inventory planners can manage accordingly to ensure they are never out of stock. Being able to predict demand for specific products can also allow you to minimise carrying costs for lower-value products.
You can also use ABC analysis to optimise your pricing. By determining which products are in high demand, you can increase their price, increasing your profits.
The ABC model allows you to prioritise your attention on the most important items and not have unnecessary attention spent on the not so important ones.