ABC Classification / Analysis of Inventory

In management, the ABC analysis is categorization technique used for finished products, or any other items lying in inventory or customers into three categories. ABC analysis divides a range of objects into three categories- A - outstandingly important; B - of average importance; C - relatively unimportant as a basis for a control scheme. Each category can and sometimes should be handled in a different way, with more attention being devoted to category A, less to B, and still less to C. 

Here, we will discuss ABC analysis particularly in the context of inventory. However similar analysis can be practiced for other range of objects like customers, employees etc. The ABC analysis provides a mechanism for ascertaining items that will have a significant impact on overall inventory cost while also providing a mechanism for identifying different categories of stock that will require different management and controls.

Popularly known as the "80/20" rule ABC concept is applied to inventory management as a rule-of-thumb. It says that about 80% of the Rupee value, consumption wise, of an inventory remains in about 20% of the items. This rule practically applies well and is frequently used by managers to plough their maximum efforts where greatest benefits, in terms of cost reduction as well as maintaining a smooth replenishment of stock, are attained.

Here, the monetary value of each individual inventory item is calculated on annual consumption basis. For determination of category of particular inventory item, the relative ratios between the number of items and the currency value of the items purchased / consumed are seen.

'A' class comprises of 10-20% of the items account for 70-80% of the consumption value and the next 15-25% items comprise 'B' class and account for 10-20% of the consumption and the balance 65-75% inventory items constitutes 'C' class and account for 5-10% of the consumption value.

‘A’ items are very important for an organization. Because of the high value of these 'A' items, are closely monitored. In addition to that, an organization needs to choose       an efficient replenishment order system (e.g. ‘Just- in- time’) to avoid excess capacity. 'B' items are important, but of course less important than 'A' items and more important than 'C' items. Therefore, 'B' items are intergroup items. 'C' items are marginally important.

As this analysis is very vital for efficient resources of the organisations and also to keep close watch on most valuable items. Hence, in the first place the categorization of different inventory items in A, B & C format is required and also each inventory item should be tag with the category so that further control could be performed based on this tagging. In present day context where the business are having large number of items and also having large volumes it is pertinent to take the decent accounting software that have the integrated inventory management solutions as well. There are some accounting software that provides the input features to categories the stock while creating the item master. That input of category tagging in the item master then help the management to get the report/MIS in respect of performing various analysis on ABC classification.

If a regular accounting software that has been used by the SME organisation is also capable of providing these kinds of value added services then such software could prove boon to small & medium type of organisation and would definitely help to improve efficiency and profitability of the organisation. Presently the market is also having some online accounting software in the market that along with providing such value-added services also provides the facility to operate from anytime anywhere. Thus, with the selection of good accounting software the entrepreneurs along with maintenance of records could add value to their business operations.