ABC analysis and its advantages in inventory management
ABC analysis can add huge advantages to inventory management processes. It's a simple way of categorising your stock items by order of importance.
In this guide, you'll learn how to conduct ABC analysis along with its advantages, limitations and examples.
What is ABC analysis in inventory management?
ABC analysis in inventory management is a common way to group stock items. You sort each item into three categories – A items are your most important, B items are less important, and C items the least.
This helps you improve stock control and resource allocation while speeding up or validating decisions about marketing, merchandising, inventory management and more.
Classes in ABC inventory management
The classes in ABC inventory management help you categorise items from the most to least important. What you deem important depends on your goals, but most businesses will look at the item's value, profit margin or demand.
"A" class items
"A" class items are your most important inventory items – you can and should invest more resources into them.
"B" class items
"B" class items are still important to your business, and you'll need to keep an eye on them.
"C" class items
"C" class items are your least important items. You should invest the least resources in them.
Advantages of ABC analysis
The advantages of ABC analysis are wide-ranging. It can help you make decisions about inventory optimisation – how you allocate resources, forecast inventory and demand, and reduce carrying costs.
Improved inventory optimisation
Improving your inventory optimisation will deliver better operational efficiency, protect revenue, and increase customer satisfaction. With ABC analysis, you can make fast decisions about everything from pricing, discounting and marketing to warehouse management and stock replenishment procedures.
Enhanced resource allocations
Enhancing resource allocations means you're making the most of your time, money and space. ABC analysis gives you a simple way to check that you're not investing too much in lower-class items, at the expense of higher-class ones. For example, are you taking special care of suppliers of A-class products, finding back-up suppliers, and buying safety stock? Should you reduce C-class stock to free up warehouse space?
Improved inventory forecasting
To improve inventory forecasting, use ABC analysis to set limits and levels for the different classes. If your A items have higher turnover than your C items, it makes sense to have safety stock and higher minimum stock levels.
Reduced storage costs
Reduced storage costs are a key advantage of ABC analysis. While you invest more resources into a small number of A items, you can confidently de-prioritise your C stock. For example, you could move to a dropshipping model, lower minimum stock levels, reduce or eliminate safety stock, or remove items altogether.
How to perform an ABC analysis
To perform an ABC analysis, you need to rank your items in order of importance. Here's how to do that:
Gather data
Gather data on your inventory. Depending on how you're sorting the items, you might collect information on value, inventory days and ratios, inventory carrying costs or the gross profit of each item. Arrange all the information on a spreadsheet or build a report in your inventory software.
Sort items by impact
Sorting items by impact is the next step. You want to order your items from the most impactful or important to the least.
Classify items
Classifying your items is simple with your ordered list. Most businesses will see that their top few items are standouts – they form your A-class. B-class items will be a slightly larger group, and the remaining bulk will be C-class.
Regularly analyse classes
Regular analysis of the classes is important to keep up with changes in the market and your business.
Example of an ABC analysis
Here's an example of an ABC analysis if your company sells printed tee shirts. All your inventory items have similar value, profit margins and holding costs, so you focus the ABC analysis on demand. You gather the inventory days of each SKU, sort the list from lowest to highest then assign the classes.
Here's how that list might look – sorted from shortest to longest inventory days, it’s easy to see what will be your A, B and C-class items
SKU number, item description and inventory days:
A-class
1234 Men's, M, sage, banana print - 1 day
4525 Women's, S, orange, banana print - 3 days
3527 Child's, S, sage, Star Wars print - 3 days
B-class
2362 Women's, M, pink flower print - 4 days
4264 Men's, M, black, flower print - 4 days
2355 Women's, L, black, flower print - 6 days
C-class
3434 Men's, L, white, corvette print - 7 days
0946 Women's, S, orange, Star Wars print - 10 days
3823 Men's, S, white, corvette print - 13 days
ABC analysis best practices
ABC analysis best practices are all about ensuring your figures are consistent and accurate.
Use inventory analysis software
Inventory analysis software removes most, if not all, of the effort of crunching these numbers. It means you can do your ABC analysis more often and be more confident in the numbers.
Keep your classifications clear and simple
Keeping your classification clear and simple is critical. It can be tempting to create subcategories for items that don't neatly fit into one class or another, but this can make your analysis much less useful down the track.
Review surplus stock levels
Reviewing surplus stock levels should be your first step after completing your analysis. You'll clearly see where you could immediately reduce stock levels to save money, improve cash flow management and reduce financial risk.
ABC analysis challenges and limitations
ABC analysis does come with some challenges and limitations, so it's a good idea to use it as just one part of your inventory management.
Limited demand pattern consideration
Limited demand pattern consideration can make ABC analysis misleading – it relies on historical data and you can often only rank products by one criterion. Say you introduce a new product you think will be a bestseller. Because the item has very few sales, ABC analysis will incorrectly put it in C-class. Similarly, the method can't account for seasonality or fluctuating demand. For example, if you conduct analysis for a food wholesaling business around Halloween, wrapped sweets may have an artificially inflated importance.
Difficult and resource-heavy implementation
It can be difficult and resource-heavy to implement ABC analysis, especially if you need to collect and analyse the data manually and if you're ranking a lot of different items.
Potential undersupply and oversupply issues
Potential undersupply and oversupply issues can crop up unless your ABC analysis considers demand forecasting. For example, your A-class items might be high-margin but low-demand, so increasing stock levels of these A-class items could lead to an oversupply.
ABC analysis FAQs
How can ABC analysis benefit cycle counting efforts?
ABC can benefit cycle counting efforts because it helps you focus on your more important items – you may choose to count those items more frequently or add extra checks. If you uncover discrepancies in your stocktake, the ABC analysis can help you decide which issues to tackle first.
What is the difference between EOQ and ABC analysis?
EOQ and ABC analysis are different inventory metrics. EOQ stands for economic ordering quantity. It balances ordering and holding costs to help you determine how much stock to order each time. ABC analysis lets you rank stock items in order of importance.
ABC: Always Be Classifying
ABC analysis can be a useful inventory management tool, helping you speed up or validate decisions, and make better use of your time, money and space. The method is a simple but blunt way of assessing your stock, so it's a good idea to consider it alongside other inventory metrics. The ABC method can be time-consuming, but to make it useful, you'll need to regularly reclassify your items. That's why using good inventory software is a necessity.
MYOB Business has inbuilt inventory management features, making your ABC analysis fast and simple – get started today.
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