What is ABC Analysis? How is it helping inventory management?

A Smith
5 min readOct 13, 2023

Inventory management is often viewed as one of businesses’ most daunting and challenging tasks. Inventory management is essential in all industries, including manufacturing, retail, e-commerce, logistics, etc. Stock control helps entrepreneurs avoid stock-out situations and maintain optimum stock levels.

One of the managers’ most efficient techniques for optimizing inventory levels is ABC Analysis. Using this method, inventory items are classified based on their perceived value. Using this method, organizations can identify products that are valuable to their customers, efficiently manage and distribute resources, lower obsolete inventory levels, and increase sales.

Throughout this article, we’ll explore how ABC classification can improve stock control practices and how ABC analysis can be used in inventory management.

ABC Analysis in Inventory Management

Using ABC analysis, inventory items are valued according to their importance to a business. In ABC, items are ranked by demand, cost, and risk information, and inventory managers classify items by those factors. To maximize their organization’s financial success, business leaders need to know which products and services are most important.

Stock-keeping units (SKUs) that are most important, based on sales volume or profitability, are referred to as “Class A” items, “Class B” items are the second-most important, and “Class C” items are the least important. Products can be classified into more than three groups by some companies.

An ABC analysis in cost accounting differs from an ABC analysis for inventory management, although it is linked to it. Activity-based costing is used by accountants in manufacturing to assign indirect costs to products or services, such as utilities or salaries.

3 Categories of ABC Analysis

An ABC analysis assumes that all goods in the market cannot be valued equally. There are three categories of them:

  • Segment A: This category contains the most essential and valuable goods. Approximately 20% of your business’s total products come from Segment A, which generates 80% of all revenue. Few goods are in this category, but it generates the most revenue.
  • Segment B: Category B products are slightly more expensive than segment B products. A little over 30% of goods are regulated by it, while 15% of its revenue is generated. Aside from that, this category includes more goods with more quantity but less utility.
  • Segment C: Category C products have higher sales but tend to be less valuable in revenue generation. Compared to categories A & B, segment C generates only 5% of revenue yet owns 50% of the company’s shares.

How Can ABC Analysis help in transforming inventory management?

Implementing ABC analysis for warehouse inventory management solutions simplifies controlling working capital costs. With this technique, obsolete inventory is reduced, resulting in a higher inventory turnover rate — changing products more often after they sell out. Automating inventory management can take inventory management to a new level and transform inventory management effortlessly. ABC analysis has a long list of benefits that help you manage inventory more effectively:

Identify a particular product category’s customer demand.

There are four stages to every product: launch, growth, maturity, and decline. The value of a product inevitably falls at some point when it reaches its optimum. Typically, this is referred to as a product’s life cycle.

To understand the lifespan of a product, it is necessary to understand how the customer demands it. As a result, ABC inventory classification becomes a spotlight, allowing businesses to analyze customer demands in detail. Analyzing consumer needs for a specific product can help business owners and managers manage their inventory. As a product’s market grows, its downfall period extends.

Product pricing strategy

Organizations can also use ABC inventory analysis to determine the optimal product pricing. It increases the value of products in inventory. Providing the products are costed strategically, categorizing them becomes relatively easy. The seller can raise the product’s price if its demand increases.

Increased levels of customer service

A warehouse manager can stock products following the value and importance of the items. As a result, they won’t have to overstock items that aren’t frequently in demand and have low margins. When inventory managers categorize items, ABC Analysis can play a pivotal role in setting service levels. As a result, supply chain management becomes even more efficient.

Streamline Your Work

By using ABC analysis, warehouse management solutions can be significantly simplified. The inventory manager often finds it hard to determine what type of items to prioritize or when to order more. However, inventory managers find that the ABC method allows them to identify the specific items they need to focus on clearly.

Forecasting demand accurately

To manage their inventory effectively, inventory planners conduct ABC analyses for each product to predict its demand. The process eliminates obsolete inventory, provides space for high-demand goods, and improves supply chain management.

Tips to implement ABC Analysis to improve inventory management

ABC analysis requires identifying your objective in advance. As soon as you have finished doing so, take the time to gather all the product information necessary to categorize your products. Using new data, closely track and inform your decisions once your products are categorized. The following steps will guide you through ABC analysis:

Decide what you want to achieve.

By optimizing inventory levels of specific products according to production volume or customer demand, ABC analysis will help you reach one of two objectives: increase cash flow or decrease procurement costs.

Gather your data

You must collect the annual expenditure for each product. If it is simple, calculate the weighted cost, ordering, carrying, and gross profit margin data.

Sort based on impact

Using ABC analysis, sort products in order of lowest to highest cost.

Determine each product’s impact on sales: Calculate the impact of each product on sales. Using the aggregated total of all items spent, divide the total annual cost by the total. If you want to compare the items on your list, you will use this number (a percentage).

% Impact = (annual item cost) / (aggregated total of all items spent) x 100

Make a list of buy categories for items.

Defining categories, implementing e-procurement, contract negotiation, shifting strategic sourcing methodologies, and consolidating your vendors could result in significant savings. A Category A item may also be in stock. A holistic approach is preferable to being too strict about the 80/20 rule.

Identify and analyze categories.

After defining the categories and strategic cost management action items, you should consider performing regular reviews to determine if your decisions have produced the desired results.

Conclusion

Inventory managers now rely on ABC inventory analysis for various tasks. This method of categorizing inventory simplifies inventory management. When you adhere to the right procedures, you can easily maximize your product value and maintain a warehouse inventory system.

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A Smith

Albert Smith is a Digital Marketing Manager with Hidden Brains, a leading enterprise web & mobile app development company specializing in IoT, Cloud & Big Data