How to Use ABC Classification for Inventory Management
- ABC Classification of inventory management
Inventory ABC Classification (as known as ABC Analysis) is a term used to define an inventory categorisation technique often used in materials management.
The ABC Classification provides a mechanism for identifying items that will have a significant impact on overall inventory cost, while also providing a mechanism for identifying different categories of stock that will require different policy settings and inventory control.
The ABC analysis is done to manage different stocked items (or SKU’s) that are not all equal in value or order frequency. A best practice is for an organisation to group their inventory into three categories (A, B, and C).
- ‘A Classification’ items are very important for an organisation. Because of the high demand of these ‘A’ items, frequent value analysis is required. These are your fast moving and typically lower value items that drive the largest percentage of your target service levels and customer satisfaction rates.
- ‘B Classification’ items are important, but of course less important than ‘A’ items and more important than ‘C’ items. These are typically mid range in inventory value and order frequency.
- ‘C Classification’ items are marginally important. Typically, very low order frequency and high inventory value. These items are usually stocked with very low quantities or not at all due to the high carrying costs associated with the stock levels.
When it comes to classifying your inventory it is usually safe to follow the Pareto Principle, also known as the 80/20 rule. The Pareto Principle is the theory that most businesses see 80% of their sales come from roughly 20% of customers, which should fall into your A classification category.
ABC Classification & The Pareto Rule for Inventory Management
ABC Classification of inventory management
ABC Classification for inventory management is a very similar approach. Classifying your inventory items into A, B, C, and D (80%, 15%, 5%, 0%) based on sales volume is an industry best practice when managing inventory.
This video gives you an good overview of how to calculate an ABC Classification for your inventory:
The most common metric to use is your Annual Sales Volume when doing ABC Classification to calculate your inventory for each group. For example, if you run the calculation and your A items represent 50% of your inventory, you may not have enough inventory for these items to meet customer demand.
Special consideration needs to be taken for new and critical items in your inventory. For new products, it’s an option to use yearly demand forecasting estimates to support demand estimates. For critical inventory items, you need special monitoring so you don’t run out of stock on the essential items that might result in customer turn elsewhere.