How does ABC inventory classification help you manage costs?

1 What is ABC inventory classification?

ABC inventory classification is a technique that divides your inventory into three categories: A, B, and C. The A category contains the most valuable and high-demand products, which account for a large percentage of your sales and profits. The B category contains the moderately valuable and medium-demand products, which account for a smaller percentage of your sales and profits. The C category contains the least valuable and low-demand products, which account for a minimal percentage of your sales and profits. The idea behind ABC inventory classification is to allocate more resources and attention to the A category products, while reducing the costs and efforts for the B and C category products.

2 How does ABC inventory classification work?

In order to implement ABC inventory classification, you must first calculate the annual usage value of each product by multiplying the annual demand by the unit cost. Next, rank the products in descending order of their annual usage value. Then, determine the cumulative percentage of the annual usage value and the cumulative percentage of the number of products for each product. Finally, assign the products to the A, B, or C category based on the cumulative percentages. For example, you can use the 80/20 rule, which states that 80% of the annual usage value comes from 20% of the products. These 20% of the products would be in the A category, while the remaining 80% of the products would be divided into B and C categories according to their relative importance.

4 What are the benefits of ABC inventory classification?

ABC inventory classification offers several benefits for your business, such as the ability to focus on the most profitable products while minimizing the waste and inefficiency of the less important ones. It also helps to balance inventory levels and reduce inventory costs, allowing you to allocate resources and capital more wisely. Furthermore, it can enhance customer service and satisfaction by ensuring the availability and quality of the products that matter the most to your customers.

5 What are the challenges of ABC inventory classification?

ABC inventory classification can present some challenges, such as needing a regular and accurate analysis of product demand and cost data, as well as periodic review and adjustment of inventory categories and policies. It may not account for variability and uncertainty of product demand and supply, or external factors that may affect inventory performance. Additionally, it may not reflect the strategic and competitive value of products, or the intangible and qualitative aspects of customer preferences and expectations. Therefore, ABC inventory classification should be used as a guide rather than a rule, and should be supplemented with other inventory management tools such as safety stock, reorder point, economic order quantity, and inventory forecasting.

6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?