SELECTIVE INVENTORY CONTROL TECHNIQUES

ABC (Always Better Control ) analysis

This technique involves the classification of inventory items

into three categories A, B and C according to their annual

cost consumption (unit cost x annual consumption).

Although the break points between these groups vary

according to individual business conditions, a common

breakdown might be as follows:

The “ABC” analysis is based on Pareto’s law (80-20 rule) that a few

high usage value items constitute a major part of the capital

invested and having low usage value constitute insignificant part of

the capital.

Category Percentage of the item Percentage of the total annual value(or group) Value of the inventories (Rs)

A 10-20 70-85 B 20-30 10-25 C 60-70 5-15

The ABC analysis facilitates analysis of yearly consumption value of

items in the store to identify the vital few items that are generally

referred to as A category items which are also vital from the financial

point of view and require careful watch, scrutiny and follow-up.

In ABC analysis the items are classified in three main categories based on the respective usage value :

Category “A” items• More costly and valuable • Have large investments but not much in number (e.g. 10% of items accounts for 75% of total capital invested in inventory)• More careful and closer control is needed• Ordered frequently but in small number• Top inventory staff controls the items• Have high carrying cost• Frequency orders of smaller size results in enormous saving • A periodic review policy is followed to minimize the shortages

Category “B” items

• Having average consumption value

( e.g. nearly 15% of the item in an inventory account

for 15% of the total investment)

• Have less importance than “A” class items but are

much costly to pay more attention on their use.

• Requires lesser degree of control than those in

category “A”

Category “C” items• Having low consumption value(e.g. nearly 75% of inventory items account only for 10% of the total invested capital )• Such items can be stocked at an operative place where people can help themselves with any requisition formality.• Can be managed in a little casual manner• For these items, a fixed-order quantity system might be used,• The order quantities can be relatively large without incurring excessive costs• A large reserve stock can also be maintained

Important Points of “ABC” Analysis•Whenever the items can be substituted for each other they

should preferably be considered as one item.

•More emphasis should be given to the value of consumption

and not to the cost per unit of item.

•While classifying as A, B and C all the items consumed on the

organization should be considered together instead of

considering them like spares, raw material, semi-finished and

finished items and then classifying as A, B, C.

•The period of consumption necessarily be one year.

Limitations of ABC Analysis•If ABC Analysis is not updated and reviewed periodically, the real purpose of control may be defeated. For example ‘C’ category items like diesel oil in the firm will become most high value items during power crisis and therefore should require more attention.

•The periodic consumption value (not the unit value) is the basis for ABC classification.

APPLICATIONS:

The application of ABC analysis extends overall of the aspects of material management like purchasing, inventory control, value analysis etc.

STEP-BY-STEP PROCEDURE FOR “ABC” ANALYSIS

STEP 1: Determine the number of units sold or used in the past one year of period.STEP 2: Determine the unit cost for each item.STEP 3: Compute the annual usage value in Rs. ($) of each item consumed as follows: Annual usage value = annual requirement x per unit cost

STEP 4: Arrange the items in a descending order according to their respective usage value computed in step 3.

STEP 5: Express the annual value of each item as percentage of the total value of all items. Also compute the cumulative percentage of annual consumption value spent.

STEP 6: Obtain the percentage value for each of the items. Also cumulate these percentage values.

STEP 7: Draw a graph between cumulative percentage of items (on x-axis) and cumulative annual percentage of usage value (on y-axis) and mark cut-off points where the graph changes slope.

Usage-Cost Data for 20 Inventoried Items

ABC Analysis Calculations

ABC Analysis Example