The ABC analysis is a relatively simple, useful way to help a business manage its inventory. With ABC analysis, a business classifies its products into different categories (A, B, and C), ranking them in order of the value they bring to the business.

This can be an excellent way to identify which items of inventory drive the bulk of your revenue, whether you have excess stock in your warehouse, and allows you to manage your inventory accordingly.

How does the ABC inventory analysis work?

To undertake an ABC inventory analysis, you first look at the different products your business sells and identify each product’s ‘annual consumption value’, using the formula:

Annual units sold/expected to be sold x cost per item = annual consumption value per product

Once you know each product’s annual consumption value, you rank those products from highest to lowest, assigning each a category of A, B, or C.

Category A items are the most important to your business – the most profitable or highest-selling products. They should reflect the top 20% of stock, representing around 80% of total consumption value. Significant resources should be dedicated to managing Category A inventory.

Category B items are still important to the business, but less so than Category A. They should reflect the next 30% of stock, representing around 15% of total consumption value. Inventory still needs solid management, but not to the same extent as Category A stock.

Category C items represent the least important inventory to a business. They should reflect the remaining 50% of inventory, which should be around 5% of total consumption value. The least resources should be allocated to managing Category C inventory.

This classification follows the ‘Pareto Principle’, which broadly works on the supposition that about 20% of efforts drive about 80% of outputs.

Benefits

There are numerous benefits to ABC inventory analysis. For one, it can help you identify which products are in high demand in your business, and can also help you allocate resources to try and maximise profits on the sales of such items – for example, by trying to negotiate better supplier terms for those high-value products, or by tightening inventory to better align with customer demand. ABC analysis can also help you identify where you may have excess stock, particularly when it comes to lower-value items, allowing you to free up warehouse space.

Drawbacks

As with every analytical model, ABC analysis isn’t perfect. For one, it’s not very adept at evaluating products that only have seasonal appeal, and it isn’t a reliable judge when it comes to new products with initial low sales volumes. Using ABC analysis also runs the risk of a business getting tunnel vision, only focusing its time and resources on category A items, when in reality, category B or C items still carry value for the business.

Ultimately, ABC analysis can be an effective inventory management tool, especially when used as part of a wider inventory management strategy. For more information on how ABC analysis may benefit your business, book some time with our team today.