Inventory management teams use ABC classification (also called ABC analysis) to help identify the most important stock items in their portfolio and ensure they focus on managing them above those less valuable. Using ABC classification, inventory is divided into three categories: A (most important), B (fairly important) and C (least important).
An ABC inventory classification system, or ABC analysis, is based on the theory that all inventory is not of equal value. Instead, it follows the Pareto Principle (the 80/20 rule), where 20% of stock accounts for 80% of the value to the business.
This post uses a working ABC analysis example to demonstrate how to classify your inventory. We’ll also show you how to take things one step further by introducing the concept of XYZ analysis. Read our post ‘The importance of ABC analysis in inventory management‘ for a broader overview of ABC inventory analysis.
Here is a working AMB analysis example, showing how to divide your inventory using annual consumption value (or usage value).
We’re going to use Sam’s Stationery business for the example:
Annual number of units sold (per item) x cost per unit
With the calculations complete, you can use your final data to review how you currently manage the inventory in each category. If you find that you’re treating all items the same, in terms of the stock you hold and the purchases you make – regardless of their category – then you’re most likely to have inefficient inventory policies. This means you’re probably over- and under-ordering on many product lines.
The good news is that there’s plenty of room for improvement, which will reduce storage, delivery and management costs.
Adapting your purchasing and inventory policies for each group is good practice, such as setting up sophisticated ordering processes for all A items. For example, checking every purchase order and spending more time discussing lead times with suppliers to guarantee the best value and timely deliveries.
In contrast, C items should take up much less of your time and could be ordered automatically to save valuable human resources.
ABC classification is a simple framework that allows you to prioritise what stock to focus on and how to manage your time. However, the model does have its drawbacks.
For starters, it’s one-dimensional, so it can only use one factor to evaluate and categorise products. ABC XYZ analysis is a more advanced classification framework you can still use in Excel. This introduces the concept of forecastability, e.g. how easy it is to forecast an item’s demand based on its demand variability. ABC XYZ analysis allows you to segment items based on their value AND forecastability, improving your stocking policies and inventory management processes.
ABC classification and XYZ analysis still have an obvious limitation – they are manual processes, so they take up valuable time. Despite some enterprise resource planning (ERP) systems or inventory management software solutions providing basic ABC classification of inventory functionality, inventory planners often use Excel spreadsheets instead. Unfortunately, as soon as you can complete your spreadsheet, it will be out dated. Products can rapidly move between categories as their sales/consumption rises and falls. Updating calculations quarterly or even monthly can be very time-consuming.
The answer is to use an inventory optimisation tool like Eazystock to automate the ABC analysis of inventory process. EazyStock allows you to categorise your inventory based on multidimensional criteria, including demand, sales frequency, number of picks, and annual consumption value.
Automating your ABC analysis of inventory classification process ensures it stays up-to-date. Daily re-classifications mean products are always managed according to the most relevant inventory policy.
For more information on how EazyStock can help with ABC classification, book a demo below or get in touch with our team.