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What is ABC Analysis?

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  • Written By: Jim B.
  • Edited By: M. C. Hughes
  • Last Modified Date: 11 November 2016
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ABC analysis is a method of inventory management that ranks the importance of different items of inventory in terms of importance to a company. This inventory method is directly linked to the consumption value of each item, which is the cost of each specific item multiplied by the amount of that item used in a specific period of time. Using the consumption value, inventory items are then ranked in three different classes via ABC analysis. The items in the A class are the most valuable to the company, while the items in the C class are the least valuable.

Inventory management is a crucial process that any business must undertake with the utmost care. A common mistake made in this process occurs when a company weighs all its inventory at the same level. In fact, different items might be much worth much more to a company even though they may be in scarce supply, and shortage of these crucial items could be damaging. One way to correct this problem is through ABC analysis, which judges all inventory items based on their worth to the business in question.

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The most crucial consideration to be made when conducting ABC analysis is the consumption value of each item. This is done by taking the volume of a specific item used and multiplying it by the cost it takes to procure this item. Once this is done, the consumption value of a specific item should be judged as a percentage of the entire inventory level. For example, if a specific part has a consumption value of $5,000 US Dollars (USD) and the entire consumption value of all the items in inventory is $10,000 USD, the aforementioned part would comprise 50 percent of the consumption value of the company's entire inventory.

Once these values are determined, ABC analysis requires that inventory managers classify all the inventory. Inventory items in the A class would be the most valuable and combined would represent about 80 percent of the money set aside for inventory. The B class would be moderately-priced inventory that comes to about 15 percent of the consumption value. Ranking last in terms of importance, the C class would be low-cost, easily-procured items representing about 5 percent of inventory.

Classifications made by ABC analysis can help a company determine the worth of its inventory and make necessary adjustments to the attention paid to that inventory. Items in Class A should be checked on a regular basis and the shipments of those items should be tracked and recorded with great care. By contrast, items in Class C should not get an excess amount of attention, since that would amount to a waste of resources.

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