# ABC method

The ABC analysis (ABC method, ABC classification) is based on the assessment of the value of given goods through the prism of their share in the value of their total annual consumption. The analysis allows to determine which of the goods owned by the company require special funds due to their high maintenance costs, with particular regard to the costs of freezing working capital. In inventory management, it is first and foremost necessary to group them both according to their value and turnover. Two methods are used for this – the ABC method and the XYZ method.

The ABC analysis is based on the Lorenz curve determination procedure. The first step is the need to organize suppliers according to declining cost indicators. The next part is the calculation of percentages of the share of purchase costs in the total purchase costs. The last step is the determination of groups A, B, C. The division of goods into groups A, B and C is made according to the value of the annual cost and consumption.

## Stock groups in the ABC analysis

### Group A

Group A – “vital” stocks, constituting 5-20% of the inventory range, but with a significant share in the value, reaching 75-80%. This group, with a high value and a large share in total material costs, should be treated with particular care in the area of:

• Bulleted list item
• Market analysis
• Detailed preparation of commercial orders
• Precise disposal procedures in the enterprise
• Proper management of inventory levels
• Precise determination of so-called safety stocks (minimum levels).

### Group B

Group B – stocks with a 15-20% share, both in the inventory size and in their value. Goods from this group can be managed using a periodic re-ordering system.

### Group C

Group C – trivial mana, with the largest share in the assortment number (60-80%) and very low share in value (around 5%). Goods from this group can be managed using the two-bin system.

## The use of the ABC method

As proved by research, the raw materials and materials from Group A that most affect the value of total consumption are not a very large set of items. These proportions are arranged more or less in such a way that about 20% of the items cover as much as 80% of the consumption value (flock method ABC is also known under the name Pareto rule or “80:20”). In relation to this group, rational premises indicate the desirability of applying an acute regime when ordering them, and therefore, in relation to them, the Just in time principle is pursued.

In relation to other materials, especially group C (“cheapest”), you can afford liberal rules for ordering and creating inventories. However, it is important that the system of sourcing goods is safe so as not to result in a lack of good C which could result in the inability to make a ready choice. The ABC analysis is a useful tool used by the purchasing department, which uses it to know which goods to focus on because their supplies occupy a high position in the total value of material consumption and total turnover.

The ABC analysis, according to the frequency of the downloads, is used to place the goods in the storage area. It is used in the following cases:

• picking up the unit to replenish the stock in the picking area

Taking into account the result of the ABC method, according to the frequency of pick-ups, it is possible to shorten the travel path of loads in the warehouse, which has a big impact on the picking process. At the moment when homogeneous units arrive in the warehouse, and in the course of completing the heterogeneous ones, the employee may collect goods from the loading unit several times in smaller quantities. A smaller number of homogeneous units issued from the storage area, without changing their form, affects the greater efficiency of the application of this criterion when placing the goods.

As a result of ABC analysis, according to the frequency of the downloads, it is possible to divide the goods in the warehouse into groups and place them in specific places in the warehouse. By assumption, the goods in group A are most often taken and should be placed as close to the edition area as possible. Group B is located further in the middle of the picking zone, while the C group charges are located farthest from the exit. This arrangement of loads allows for the maximum reduction of time and distance to be traveled by the loading units.

## Application of the ABC classification

Process control

In an enterprise undertaking many orders, the ABC method often shows that controlling several of them allows controlling the vast majority of tasks.

Inspection of used materials

Control of the first group, 20% of items in the warehouse, allows you to control 80% of material costs incurred. The first group should be under special control, the second group, about 20-50% of the item can be subjected to less control, and the third group, representing 50-100% of the position can be treated freely. First, second and third groups are usually referred to as groups A, B and C.

Reducing diversity

Thanks to the ABC analysis it is possible to draw many conclusions – for example, by classifying loads according to the share in the company’s revenues, items from group C should be omitted. Such an application does not always have to be justified, because not all items in this group had to reach market maturity. The ABC method helps in identifying problems, but should not be an absolute means of qualification, but only a tool to help in making decisions.

Quality management

When assigning the causes of defects, it is not uncommon to find that a large number of defects are caused by a few causes.

Cost management

The ABC method can be helpful when searching for unnecessary costs. In a given community, a position with the smallest species weight is found, but in significant quantities. Thanks to this, it is possible to consider reducing the fixed costs, which are the same for all items of a given group, in relation to the items from the group C.

Maintenance service

It consists in counting the lost time resulting from the machine failure, which facilitates the arrangement of the device operation plan.

## Uses of ABC Analysis

The ABC analysis is widely used in supply chain management and stock checking and inventory system and is implemented as a cycle counting system.  It is most important for companies that seek to bring down their working capital and carrying costs. This done by analysing the inventory that is in excess stock and those that are obsolete by making way for items that are readily sold. This helps avoid keeping the working capital available for use rather than keeping it tied up in unhealthy inventory.

When a company is better able to check its stock and maintain control over the high-value goods it helps them to keep track of the value of the assets that are being held at a time. It also brings order to the reordering process and ensures that those items are in stock to meet the demands.

The items that fall under the C category are those that slow-moving and need not be re-ordered with the same frequency as item A or item B. When you put the goods into these three categories, it is helpful for both the wholesalers and the distributors to identify the items that need to be stocked and those that can be replaced.

For Example- ‘H&M’ manufactures 80% of its retail inventory in advance and introduces the remaining 20% based on the most current market trends.

Similarly, ‘Amazon’ does not keep stock of every single item offered on its website. The stocks of only the popular items that are frequently purchased are maintained. If there is an order for an unpopular item, then Amazon would request it from its distributor, who would then ships it to the company.

## Advantages of Implementing the ABC Method of Inventory Control

• This method helps businesses to maintain control over the costly items which have large amounts of capital invested in them.
• It provides a method to the madness of keeping track of all the inventory. Not only does it reduce unnecessary staff expenses but more importantly it ensures optimum levels of stock is maintained at all times.
• The ABC method makes sure that the stock turnover ratio is maintained at a comparatively higher level through a systematic control of inventories.
• The storage expenses are cut down considerably with this tool.
• There is provision to have enough C category stocks to be maintained without compromising on the more important items.

## Disadvantages of using the ABC Analysis

• For this method to work and render successful results, there must be proper standardization in place for materials in the store.
• It requires a good system of coding of materials already in operation for this analysis to work.
• Since this analysis takes into consideration the monetary value of the items, it ignores other factors that may be more important for your business. Hence, this distinction is vital.

The ABC model works in a manner as to get prime attention to the important items or the critical few and not have unnecessary attention be spent on the not so important items or the trivial many. Each category has a differing management control in place. This prioritization of attention and focus is vital to keep the costs in check and under control in the supply chain system. To get the best results it is important that items that involve a lot of costs are given the due management attention.

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