How can you use ABC analysis to categorize inventory items?

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Inventory management is a crucial aspect of running a successful business. You need to balance the availability, cost, and demand of your products, and avoid overstocking or understocking. One way to optimize your inventory control is to use ABC analysis, a method that categorizes inventory items based on their value and importance. In this article, you will learn how to use ABC analysis to prioritize your inventory items and allocate your resources more efficiently.

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Geoffrey Y. Adjorlolo BSc, MSc, MCIPS

Logistics and Supply Chain Management Professional {} Procurement Expert {} Human Resource Management & Organisational…

1 What is ABC analysis?

ABC analysis is a technique that divides inventory items into three groups: A, B, and C. A items are the most valuable and profitable, and usually account for a small percentage of the total inventory but a large percentage of the total revenue. B items are moderately valuable and profitable, and usually account for a medium percentage of both inventory and revenue. C items are the least valuable and profitable, and usually account for a large percentage of the inventory but a small percentage of the revenue. The exact criteria and percentages for each group may vary depending on your business goals and industry standards.

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Geoffrey Y. Adjorlolo BSc, MSc, MCIPS

Logistics and Supply Chain Management Professional {} Procurement Expert {} Human Resource Management & Organisational Development Professional {} Business Developer {} Contruction Sense {} Event Director
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ABC inventory analysis is the process of classifying inventory by priority, based on given criteria. With the insights that this analytical approach provides, we can identify meaningful opportunities to optimise inventory levels. This useful tool helps supply chain teams to reduce carrying cost and unlock working capital. But more importantly, a good ABC analysis should help increase sales turnover through attaining better availability on the products that matter most to the customer. As a result, businesses that take advantage of this approach run leaner and more efficiently.

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2 Why use ABC analysis?

The main benefit of using ABC analysis is that it helps you focus your attention and resources on the most important inventory items, while reducing the costs and risks associated with the less important ones. This can improve your cash flow by reducing the amount of capital tied up in inventory, as well as enhance customer satisfaction through ensuring availability of high-demand products. Furthermore, ABC analysis can streamline ordering and replenishment processes, minimize inventory holding and carrying costs, and reduce obsolescence and shrinkage by managing inventory turnover and security.

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Geoffrey Y. Adjorlolo BSc, MSc, MCIPS

Logistics and Supply Chain Management Professional {} Procurement Expert {} Human Resource Management & Organisational Development Professional {} Business Developer {} Contruction Sense {} Event Director
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To begin with, you should ask yourself: When should I order? How many should I order? What service level should I assign to each item? Categorise your items 1. Category A items = those items representing the top 80% of your assortment. 2. Category B items = those items representing the next 15% of your assortment. 3. Category C items = the remaining items making up the final 5% of your assortment.

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3 How to use ABC analysis?

Using ABC analysis requires gathering data on inventory items, such as quantity, price, sales volume, and profitability. Then, calculate the annual consumption value of each item by multiplying the quantity by the price. Rank the items in descending order of their annual consumption value and determine the cumulative percentage of the annual consumption value and the cumulative percentage of the total number of items. Assign each item to a group based on a predefined threshold, such as 80/20/10 for A/B/C. Finally, review and adjust the groups periodically based on changes in demand, costs, and market conditions.

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Geoffrey Y. Adjorlolo BSc, MSc, MCIPS

Logistics and Supply Chain Management Professional {} Procurement Expert {} Human Resource Management & Organisational Development Professional {} Business Developer {} Contruction Sense {} Event Director
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Determined whether you need a simple analysis or something more complex, and the management team have outlined the main criteria, the next step is to perform the analysis. To keep things simple, we will use margin as our main criteria in our worked ABC Analysis below. 1) Prepare your data Before you begin your analysis, you will need the right data. To do this, extract the data with the selected criteria over the desired date range at an item level. In our example, we need to extract the margin of each SKU. 2) Sort your data Now, take each ABC criteria in turn and sort your products from highest to lowest. In the ABC analysis example below, we have organised the data in descending order based on the margin each item offers.

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4 What are the best practices for ABC analysis?

To make the most of ABC analysis, you should consider multiple criteria to categorize your inventory items, such as lead time, availability, quality, and customer preference. Segment your inventory items by product type, category, location, or channel for a more granular view. Additionally, apply different inventory policies and techniques for each group, like reorder point, safety stock, cycle counting, or inventory optimization. To evaluate success, monitor and measure your inventory performance indicators like turnover, fill rate, service level, and accuracy. Moreover, communicate and collaborate with suppliers, customers, and internal stakeholders to align your inventory goals and expectations.

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5 What are the limitations of ABC analysis?

ABC analysis is a useful tool for inventory management, however, it has some limitations. It may not capture the variability and uncertainty of demand and supply, nor account for the interdependence and complementarity of inventory items. Additionally, it may not reflect the strategic and competitive value of inventory items. Moreover, it may require a lot of data collection and analysis, which can be time-consuming and complex. As such, you should use ABC analysis as a guide, not a rule, and combine it with other inventory methods and tools to achieve optimal results.

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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?

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How can you use ABC analysis to categorize inventory items?

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1 What is ABC analysis?

2 Why use ABC analysis?

3 How to use ABC analysis?

4 What are the best practices for ABC analysis?

5 What are the limitations of ABC analysis?

6 Here’s what else to consider

Business Administration

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How can you use ABC analysis to categorize inventory items?

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1 What is ABC analysis?

2 Why use ABC analysis?

3 How to use ABC analysis?

4 What are the best practices for ABC analysis?

5 What are the limitations of ABC analysis?

6 Here’s what else to consider

Business Administration

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