I nventory Classification System

Inventory items are not of equal importance in terms of

dollars involved, profit potential, sales or usage volume, or
stockout penalties
Example : Producer of Electrical Equipment
Inventory carried includes generators, coils of wire, and
miscellaneous nuts and bolts among other items in stock
Unrealistic to devote equal attention to each of these items
Instead, a more reasonable approach would be to allocate
control efforts according to the relative importance of
various items in inventory
A-B-C approach classifies inventory items according to some measure of
importance, usually dollar usage (i.e. dollar value per unit multiplied by
annual usage rate), and allocating control efforts accordingly
I nventory Classification System
ABC Analysis divides on-hand inventory into three
classifications on the basis of annual dollar value.
It is an inventory application of the Pareto principle which
states that there are a critical few and trivial man.
Idea is to establish inventory policies that focus resources
on the few critical inventory parts and not the many trivial
ones.
It is not realistic to monitor inexpensive items with the
same intensity as very expensive items.
I nventory Classification System
ABC Classification
Annual dollar volume = annual demand x cost per unit
Dollar volume is a measure of importance; an item low in
cost but high in volume can be more important than a
high-cost item with low volume.
Typically three (3) classes of items are used: A (very
important), B (moderately important), and C (least
important)
The actual number of categories may vary from
organization to organization, depending on the extent to
which a firm wants to differentiate control efforts.
I nventory Classification System
ABC Classification
Class A items generally account for about only 15% to 20%
of the number of items in inventory but represent 70% to
80% of the total dollar usage
Class C items may represent only 5% to 10% of the annual
dollar volume but about 55% to 60% of the total inventory
items
Class B items are those inventory items with medium annual
dollar volume, about 15% to 20% of the total value
representing about 30% of the the number of inventory items
Percentages vary from firm to firm, but in most instances a
relatively small number of items will account for a large share
of the value or cost associated with an inventory
I nventory Classification System
ABC Classification
Class A items should receive a close attention through
frequent reviews of amounts on hand and control over
withdrawals.
Class C items should receive only loose control (two-bin
system, bulk orders).
Class B items should have controls that lie between A & C.
Class C items are not necessarily unimportant; incurring a
stock out of C items such as the nuts and bolts used to
assemble manufactured goods can result in a costly
shutdown of an assembly line (due to low annual dollar
volume, larger orders or ordering in advance will help
without incurring much additional cost).
Steps To Solve An A-b-c
Problems
Find out the unit cost and the usage of each material over a
given period.
Multiply the unit cost by the estimated annual usage to obtain
the net value.
List out all the items and arrange them in the descending value.
(Annual Value)
Accumulate value and add up number of items and calculate
percentage on total inventory in value and in number.
Draw a curve of percentage items and percentage value.
Mark off from the curve the rational limits of A, B and C
categories.
Inventory Classification System
Example
ABC Calculation
(1) (2) (3) (4) (5) (6) (7)
ITEM
STOCK
NUMBER
PERCENT
OF
NUMBER
OF ITEMS
STOCKED
ANNUAL
VOLUME
(UNITS) x
UNIT
COST =
ANNUAL
DOLLAR
VOLUME
PERCENT
OF ANNUAL
DOLLAR
VOLUME CLASS
1 20% 1,000 $ 90.00 $ 90,000 38.8% A
2 500 154.00 77,000 33.2% A
3 1,550 17.00 26,350 11.3% B
4 30% 350 42.86 15,001 6.4% B
5 1,000 12.50 12,500 5.4% B
6 600 $ 14.17 $ 8,502 3.7% C
7 2,000 .60 1,200 .5% C
8 50% 100 8.50 850 .4% C
9 1,200 .42 504 .2% C
10 250 .60 150 .1% C
8,550 $232,057 100.0%
Inventory Classification System

A Items
B Items
| | | | | | | | | |
10 20 30 40 50 60 70 80 90 100
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80
70
60
50
40
30
20
10
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Percentage of inventory items
C Items
Some of the benefits of using
ABC classification
Manage the goods in the inventory in a proper manner
You get to have a thorough knowledge about the amount and
quantity of goods that might be needed
You will be able to prioritize the importance of goods that are
need in the production process.
You will be able to identify the items that make a significant
impact to the whole of the production process
You will understand the true nature of the quality and quantity
of the goods used in the production process.