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What is ABC Analysis for Inventory Management?
ABC analysis is a technique used in inventory management to classify items in a stock based on their level of importance or value to the business. The technique is based on the Pareto principle, which suggests that a small percentage of items in a stock account for a significant proportion of the total value. If you’re an ecommerce business using a platform like Shopify, ABC analysis can add real depth to your understanding of your stock and allow you to make smarter decisions in inventory management.
How does ABC Analysis Create the Different Groups?
The usual process to conduct ABC analysis involves the following steps:
Identify Inventory: List all the items that you have in your inventory.
Determine Annual Consumption Value: Calculate the annual consumption value of each item by multiplying the annual demand by the cost per unit.
Rank Inventory: Rank the items from the highest to the lowest based on their annual consumption value.
Calculate Cumulative Percentage: Calculate the cumulative annual consumption value and the cumulative percentage of the total items.
Categorize into Groups: Divide the items into A, B, and C categories based on their annual consumption value and cumulative percentage. Generally, the top 70-80% of the cumulative consumption value is category A, the next 15-25% is category B, and the remaining 5-10% is category C.
Remember, ABC analysis is a flexible tool, and the specific percentages for each category can be adjusted based on your business's unique needs and priorities. Additionally, while this analysis is typically based on the cost significance of the items, you can also consider other factors like lead time, availability, or the item's importance to your production process.
In our example diagram below we have used:
In ABC analysis, items are classified into three categories: A, B, and C, based on their value or importance. Category A items are high-value items that account for a significant portion of the total value of the inventory but make up only a small percentage of the total items. Category B items are medium-value items that account for a moderate proportion of the total value and make up a moderate percentage of the total items. Category C items are low-value items that account for a small proportion of the total value but make up a large percentage of the total items.
How can ABC Analysis help a Business?
The purpose of ABC analysis is to help businesses prioritize their inventory management activities, such as ordering, stocking, and monitoring. For example, category A items may require closer monitoring and more frequent ordering to avoid stockouts, while category C items may be ordered less frequently or in smaller quantities to optimize inventory holding costs. A robust inventory management system, such as Unleashed, can also greatly support efficient stock control and works brilliantly alongside regular ABC analysis.
Getting on top of your inventory management and setting up ABC analysis can feel like a daunting task. If you’d like to speak to an expert, book a discovery call with Phil and the Outserve team. We are here to talk about all things ecommerce, inventory management, cloud accounting and reporting especially if you’re interested in using Unleashed, Xero or A2X.