ABC analysis is a simple way to categorize inventory based on importance. It helps businesses focus on the most valuable stock items. This method is widely used for inventory management, supply chain control, and warehouse optimization.
What is ABC Analysis?
ABC analysis divides inventory into three categories:
- Category A: High-value items with low frequency of sales.
- Category B: Moderate value items with moderate frequency.
- Category C: Low-value items with high frequency of sales.
The goal is to prioritize resources on the most valuable stock.
Steps to Calculate ABC Analysis
Let’s break it down into simple steps.
Step 1: Gather Inventory Data
Collect data on all inventory items. The most important fields are:
- Item name
- Annual usage (number of units sold per year)
- Cost per unit
Step 2: Calculate Annual Usage Value
For each item, multiply the Annual usage by the Cost per unit. This gives the total value of that item used per year.
Formula:
Annual Usage Value = Annual Usage × Cost per Unit
Step 3: Sort Items by Annual Usage Value
Sort the items in descending order based on their Annual Usage Value. The most valuable items go to the top.
Step 4: Calculate Cumulative Percentage
Next, compute the cumulative percentage of each item’s contribution to the total inventory value.
Formula:
Cumulative % = (Cumulative Annual Usage Value) ÷ (Total Inventory Value) × 100
Step 5: Categorize Items into A, B, and C
Now, divide the items into three categories based on their contribution:
- Category A: Top 70–80% of total inventory value.
- Category B: Next 15–25% of total inventory value.
- Category C: Last 5–10% of total inventory value.
Working Example
Let’s say a company has five products:
| Item | Annual Usage | Cost Per Unit | Annual Usage Value |
|---|---|---|---|
| Item 1 | 1,000 | $50 | $50,000 |
| Item 2 | 5,000 | $10 | $50,000 |
| Item 3 | 10,000 | $5 | $50,000 |
| Item 4 | 50,000 | $1 | $50,000 |
| Item 5 | 100,000 | $0.50 | $50,000 |
The total inventory value is $250,000. Now, we sort and compute cumulative percentages:
- Item 1: 20% of total value
- Item 2: 40% of total value
- Item 3: 60% of total value
- Item 4: 80% of total value
- Item 5: 100% of total value
Now, we classify:
- Category A: Items 1, 2, 3 (top 70–80%)
- Category B: Item 4 (next 15–25%)
- Category C: Item 5 (last 5–10%)
Why Use ABC Analysis?
This method helps businesses by:
- Focusing on the most valuable products.
- Improving inventory control.
- Reducing storage costs.
- Better forecasting and planning.
Final Thoughts
ABC analysis is a powerful yet simple tool. It helps businesses prioritize effort on their most important stock. Just follow these easy steps, and you’ll have a well-organized inventory in no time!
