ABC Classification is an inventory control technique that classifies inventory items into three categories.
We classify inventory items into different categories to properly manage the materials and reduce the overall inventory cost.
ABC method cuts down the cost involved in checking all inventory items by applying different level of control for different categories.
How to classify Inventory Items?
In ABC analysis, materials are categorized into three categories namely A, B, and C. This classification is done based on the value and the quantity of the items.
Category A :
Inventory items with high monitory value are put into category A.
Normally organizations spend huge money on purchasing A category items.
These items account for about 80 to 90% of the cost to the company.
Therefore these items are considered as highly important materials.
Since the value of these items is more, we exercise more control over these items.
Accurate forecasting of the quantity needed for production has to be done for these materials
Since A category items are most valuable materials, senior-level management has to get involved in making buying decisions for these items A category items account for about 10-20% of the total inventory and account for 70-80% total consumption value
Inventory items with moderate quantity and average value are grouped as B category items. These items are considered as important but not critical for the business. They include about 30-40% of the total inventory and account for 30-40% of the total consumption value.
Some items in the inventory are needed in huge quantity for the operations. But the value of these items will be minimal.
Therefore such materials or items are grouped as Category C.
Normally C category items are readily available items with low cost.
About 70-80% of the total inventory items belong to this group but their consumption value is just 10-20%.
These items can have relaxed control from the management Establishing Inventory Control
After grouping all the materials into different categories, the next will be deciding on the level of control to be established.
Though A category items are less in volume, they are important in terms of cost.
That is why in inventory management, more control is placed on these items.
There should be a constant control on these items.
Periodic monitoring of the availability of these stocks has to be done.
Management has to put strict control on these items.
Category B items are considered to be moderately important based on their value. Therefore these items will be monitored on a need basis.
Category C items have very less value and therefore less effort has to be put in controlling these items.
Steps in ABC Classification
ABC classification can be made using an excel sheet with these two basic data
1) Inventory Volume
2) Inventory Cost
All the inventory items have to be arranged in descending order of cost. Using Excel formulas, we can then calculate the percentage that each item represents in the total cost.
In the next step, sum up the percentage until you get 80% of the cost. Items that come in these rows will be grouped as A category. The same procedure is repeated to find out B and C category items.