ABC Analysis - Essay Example

ABC Analysis Introduction ABC Analysis of inventory control is based on the Pareto principle that for many events, roughly 80% of the effects come from 20% of the causes (Bunkley, 2008). ABC analysis is the method of dividing on-hand inventory items into three classifications based on annual dollar volume (Heizer et.al. 2009, pg. 449). The ABC methodology of inventory control is based on the value of inventory consumption for each product every year. For the ABC analysis of the inventory, we categorize all inventory items into three categories: A category items: These are those products that are very critical to the organization and require frequent analysis of the value of the inventory.

B category items: These are the set of products that lie second in the ranking of importance to the organization. These need to be valued less frequently than the ‘A’ category. C category items: C category items in the inventory are the least important for the organization. The importance of the product in the inventory can be calculated by multiplying the average cost per unit by the actual usage in the last year.ExampleLet us see an example where the inventory of an organization has 10 items with the usage in no of units and the unit cost per each item as given in the table below: Item No.

Average usage (Units)Unit Cost ($)11532451531715423155716648120715068192917310183The first step in the ABC analysis will include the calculation of Annual usage in $ and ranking them according to the same. The table calculated with the same is shown below: Item No. Average usage(Units)Unit Cost($)Annual Usage($)Rank6481205760171506900224515675342315345431715255557161126101835479173518115345981923810Now, we calculate the cumulative annual usage of each of the top items and then cumulative annual usage as a percentage of the total annual usage.

The same is shown in the table below: Item No. Average usage(Units)Unit Cost($)Annual Usage($)RankCumulative Annual Usage ($)Annual Usage (%)64812057601576069.95%715069002666080.87%245156753733589.07%423153454768093.26%317152555793596.36%57161126804797.72%10183547810198.37%9173518815298.99%1153459819799.54%819238108235100.00%We categorize the items as per the annual usage (%) of the items. Products below 70% of the cumulative annual usage will be categorized as A. Products with annual usage (%) between 70% and 95% will be categorized as B and the remaining C.

The same is highlighted here in the table: Item No. Average usage(Units)Unit Cost($)Annual Usage($)RankCumulative Annual Usage ($)Annual Usage (%)Category64812057601576069.95%A715069002666080.87%B245156753733589.07%B423153454768093.26%B317152555793596.36%C57161126804797.72%C10183547810198.37%C9173518815298.99%C1153459819799.54%C819238108235100.00%CAs we can see from the table, item no. 6 which has annual usage as a percentage of 69.95% is a category A product. At the same time, items nos 7, 2, and 4 are Category B and the remaining are Category C.