Inventory Management 5 min read
October 28, 2022 by Malika Sanon - 5 min read
- Why Should You Use ABC Analysis in Inventory Management?
- The Pareto Principle & ABC Analysis
- What Are The Benefits Of ABC Inventory Analysis?
- How To Use ABC Analysis for Inventory Management?
- Final Thoughts
ABC Analysis, also known as Always Better Control Analysis, is one of the most commonly used inventory management methods. This analysis moves items into three groups (A, B, & C) based on their level of value in a business.
Classifying inventory with ABC analysis helps businesses figure out their inventory, optimize their operations, and make smarter decisions. In this blog, we will understand the ABC analysis in-depth, explain how it can be used, and help you decide if that’s what you need for your business.
Why Should You Use ABC Analysis in Inventory Management?
ABC analysis is the method of inventory management to store inventory into three main buckets.
A Items: This is your inventory with the highest annual consumption value. It should be your highest priority and rarely, if ever, a stockout.
B Items: Inventory that sells regularly but less than A items. Often inventory costs more to hold than A items.
C Items: This is the rest of your inventory that doesn’t sell much, has the lowest inventory value, and makes up the bulk of your inventory cost.
Inventory categorisation is exceptionally essential for physical products because it protects your profit margins and also prevents you from losses. It is also the first step in reducing obsolete inventory, supply chain optimization, increasing prices, and forecasting demand.
The Pareto Principle & ABC Analysis
The Pareto principle, also known as the 80/20 rule, states that 80% of outputs are caused by 20% of inputs.
The principle was discovered by Italian economist Vilfredo Pareto, who observed that 80% of the peas in his garden came from only 20% of the pods he planted. More significantly, he noticed a similar ratio when he realized that 80% of the land in Italy was owned by 20% of the population.
After Pareto’s discovery, the principle changed how economics is studied and how we understand the distribution of the world’s resources.
ABC inventory analysis is also based on the Pareto Principle, which means it’s often the case that about 20% of a company’s inventory accounts for 80% of its value. This helps leaders make more informed decisions.
ABC analysis brings simplicity to inventory analysis by putting all of your stock into three buckets, enabling you to make well-informed decisions.
What Are The Benefits Of ABC Inventory Analysis?
Accurate Demand Forecast
ABC analysis helps inventory planners predict demand for specific products and manage their inventory accordingly. This also minimizes keeping an obsolete inventory, helps create space for high-demand products, and also improves supply chain management.
Smooth Control Of High-Value Inventory
For most businesses’ a majority of their profits depend on A-class inventory. ABC analysis helps you identify those items in real-time, monitor their demand, and ensure they never go out of stock. By channelling your resources towards high-priority inventory, you can be assured you’re putting the odds of success in your favour.
ABC analysis can optimize your pricing strategy for products that bring the most revenue to your business. Once you understand which products are in high demand, you can decide their price accordingly, which can significantly impact profits.
How To Use ABC Analysis for Inventory Management?
To apply ABC analysis to your business, follow these simple steps-
1. Classify The Inventory
Your inventory classification depends on the business you’re running and your company’s objectives. Your classification largely relies on the type of inventory you have in your business and the way your business operates.
Any metric you use measures your inventory’s consumption value for a given period. Standard metrics are total sales, gross margin, purchasing, and holding costs. After calculating each item’s percentages, place them in your A, B, and C categories.
2. Create Rules For Inventory Categories
For all three categories (A, B, and C), we need to create rules or actions on how your classifications should function.
3. Monitor & Look For Opportunities To Change Classes
Your classification mix will change as you grow and add items to your inventory. If you continue to monitor your analyses, you’ll start to notice patterns and forecast which inventory is most vital for you and which is least important. By always having the right inventory mix, your operations will run more efficiently, and cash flow nightmares will eventually be a thing of the past.
Shiprocket Fulfillment has fulfillment centers located in different cities across India. This means you can decentralize your inventory, store it closer to buyers, and save on shipping costs while providing one-day and two-day delivery.
Not just this, the right technology stack, like warehouse management systems, order management systems, and logistics operations, enables your business to expedite deliveries. We are also equipped to reduce your order-to-ship time and meet the stringent requirements of marketplaces.
Classifying inventory with ABC analysis will help you sort out your inventory and make more informed decisions. Inventory categorisation is essential for physical products and will protect your profit margins and save you from losses.