Where there are a large number of items in the inventory, it becomes essential to have an efficient control over all items of stores. However comparatively, great care should be given to items of higher value. The movements of certain manufacturing concerns may consist of a small number of items representing a major portion of inventory value and a large number of items may represent a minor portion of inventory value. In such cases, a selective approach for inventory control should be followed.
The most modern technique for controlling the inventory is a value item analysis popularly known as ABC analysis which attempts to relate, how the inventory value is concentrated among the individual item. This analysis is based on Pareto’s law. Pareto’s law states that a fewer items of higher usage having high investment value should be paid more attention than a bulk of items having low usage value and having a low investment in capital. Under this analysis, all items of stores are divided into three main categories — A, B and C. Category A includes the most important items which represent about 60 to 70 per cent of the value of stores but constitute only 10 to 15 percent items. These items are recognised for special attention category B includes lesser important items representing an investment value of 20 to 25 percent and constitute a similar percentage of items of stores. Category C consists of the least important items of stores and constituted 60 to 70 percent of stores items representing only a capital investment between 10 to 15 percent. Close attention is paid to items falling in category A and the best items of category C. This classification of items into A, B and C categories is based upon value, usage, rate and criticality of items and these variables are given due weightage in categorising the items the term ABC implies Always Better Control.
Steps in ABC Analysis
Though no definite procedure can be laid down for classifying the inventories into A, B and C categories as this will depend upon a number of factors such as nature and varieties of items specific requirements of the business place of items in the production, etc. These factors vary from business to business to business and items to item. However, following procedure can be followed:
Firstly, the quality of each material expected to be used in a given period should be estimated.
Secondly, the money value of the items of materials, so chosen should be calculated by multiplying the quantity of each item with the price.
Thirdly, the items should be rearranged in the descending order of their value irrespective of their quantities.
Fourthly, a running total of all the values and items will then be taken and then the figure so obtained should be converted into percentage of the gross total.
Fifthly and lastly, it will be found that a small number of a first few items may amount to a large percentage of the total value of the items. The management, then, will have to take a decision as to percentage of the total value or the total number of items which have to be covered by A, B and C categories.
Advantages of ABC Analysis
Advantages of ABC analysis are as follows:
1. Increase in Profitability:ABC analysis ensures a close control over the items of A, B and C categories and due to control over A category items, the capital investment over inventory reduces.
2. Other Uses:The technique of ABC analysis is based on the principle of management by exception and can be used in areas like, distribution, sales, etc.