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# Inventory Control - ABC Analysis & Inv Counting

By - Posted on 11 February 2012

Control of inventory is exercised by controlling individual items called stockkeeping- units (SKUs). 4 questions must be answered:

- What is the importance of the inventory item?
- How are they to be controlled?
- How much should be ordered at one time?
- When should an order be placed?

The ABC inventory classification system answers the first two questions by determining the importance of items and thus allowing different levels of control based on the relative importance of items.
Usually this is based on annual dollar usage, but other criteria may be used.

The ABC principle is based on Pareto’s law.
As applied to inventories, it is usually found that the relationship between the percentage of items and the percentage of annual dollar usage follows a pattern in which:

- A About 20% of the items account for about 80% of the dollar usage,
- B About 30% of the items account for about 15% of the dollar usage,
- C About 50% of the items account for about 5% of the dollar usage.

This type of distribution can be used to help control inventory.

ABC analysis:
- Establish the items characteristics that influence the results of inventory management,
- Classify items into groups based on the established criteria,
- Apply a degree of control in proportion to the importance of group.

The procedure for classifying by annual dollar usage is as follows:
- Determine the annual usage for each item;
- Multiply the annual usage of each item by its cost to get its total annual dollar usage;
- List the items according to their annual dollar usage;
- Calculate the cumulative annual dollar usage and the cumulative percentage of items;
- Examine the annual usage distribution and group the items into A, B and C groups based on percentage of annual usage.

Control based on ABC classification
Using the ABC approach, there are 2 general rules to follow:
- Have plenty of low-value items. carrying extra stock of C items adds little to the total value of the inventory. C items are really only important if there is a shortage of one of them;
- Use the money and control effort saved to reduce the inventory of highvalue items. A items are extremely important and deserve the tightest control and the most frequent review.

Different controls used with different classifications might be the following:
- A items: high priority. Tight control including complete accurate records, regular and frequent review by management, frequent review of demand forecasts and close follow-up and expediting to reduce lead time;
- B items: medium priority Normal controls with good records, regular attention and normal processing;
- C items: lowest priority Simplest possible control – make sure they are plenty. Simple or no records; perhaps use a two-bin system or periodic review system. Order large quantities and carry safety stock.

Periodic physical counting are most often performed annually, where all items are counted in a short period of time, often requires shutdown of operations and the use of many diverse personnel. This method does not support day-to-day inventory record accuracy. Its primary purpose is to validate the aggregate inventory values used for financial accounting statements.

Cycle counting occurs continuously, with a few items, with specified criteria, counted each day by experienced and trained employees. Identification of the trigger for physicalcount activity can be based on one of the following rules:
◊ ABC classification
◊ When a reorder is indicated
◊ When a replenishment lot is received
◊ When the record indicates a zero balance
◊ When a record balance becomes negative
◊ Every specified number of transactions

Fixing Accuracy Targets
Goal of any organization is to achieve 100% inventory accuracy. Practically achieving 100% accuracy target is not easy and can only be achieved over a period of time through cycle counting, where the causes of errors are discovered and corrected. As a practical matter, goals somewhat less that 100% are targeted and might be established based on ABC classification of the inventory items.

Obsolescence of Inventory
Inventory obsolescence is one the biggest concern areas to the management. It is important for an organization to be able to identify the obsolete inventory and take actions to dispose it off. It has been observed, that it almost always results in an inventory write-off on the organization’s income statement, which, as a direct subtraction from income, reduces profit.

Reasons of Obsolescence
Various reasons for inventory obsolescence are:
Engineering Changes
Spoilage
Technical Obsolescence
Defects

Disposal of Obsolete Inventory
Most commonly used tactics for disposal of obsolete inventory in the industries are:
Alternate use
Return back to the vendor
Sale in the market through various channels

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