ABC method

From CEOpedia | Management online

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.

ABC analysis according to the frequency of downloads

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:

  • downloading the unit for its release, but without changing the form
  • downloading in the course of picking (if the picking zone has not been marked)
  • 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.

Examples of ABC method

  • ABC Analysis is commonly used in inventory management to identify which items should be given priority. For example, a retail store may use the ABC method to prioritize items that have high sales volume and/or high value. This would help them identify which items should be stocked more frequently and which items may be stocked less often.
  • ABC Analysis is also used in project management. For example, a project manager may use the ABC method to prioritize tasks based on their importance, complexity, and urgency. This would help them identify which tasks should be given priority and which tasks can be delegated to other team members.
  • ABC Analysis is also used in budgeting. For example, a business may use the ABC method to prioritize expenses based on their importance and cost. This would help them identify which expenses are most important and should be given priority, and which expenses can be reduced or eliminated.

Advantages of ABC method

The ABC method of inventory analysis is a popular and effective tool used to identify the most important items in a company's inventory. The advantages of this method include:

  • Improved inventory management: By categorizing items into A, B, and C categories, it becomes easier to prioritize which items to order, how much to order, and when to order.
  • Reduction of stock-outs: By focusing on the most important items, companies can ensure that they always have the right amount of inventory on hand.
  • Increased efficiency: By understanding the value of each item, companies can better manage their production costs and optimize their supply chain.
  • Increased profitability: By focusing on the most important items and keeping their inventory levels low, companies can save on storage costs and reduce their overall inventory costs.

Limitations of ABC method

The ABC method is a useful inventory management tool, but it is not without limitations. These include:

  • The ABC method is based on the assumption that the total annual consumption of goods is known, which may not always be the case.
  • The ABC method does not account for the seasonal fluctuations in demand for certain goods, meaning it may not be as effective in managing inventory during certain times of the year.
  • The ABC method assumes that the costs of freezing working capital are known, which may not be the case in certain scenarios.
  • The ABC method only takes into account the cost of goods, not the potential sales generated from them, which makes it difficult to accurately assess the true value of certain goods.

Other approaches related to ABC method

In addition to the ABC method, the following methods are used to assess the value of goods owned by a company:

  • The Pareto principle, or the 80/20 rule, which states that 80% of the effects come from 20% of the causes. This method suggests that 80% of the value of a company's inventory is contained in 20% of its parts, so it is necessary to focus on these items first.
  • The XYZ method, which is a variation of the ABC method, but places greater emphasis on the frequency of the item's turnover. This method divides inventory into three categories: X - those items with low value and low turnover, Y - those items with a moderate value and turnover, and Z - those items with a high value and turnover.
  • The VED method, which stands for Vital, Essential and Desirable. This method divides inventory into three categories based on their importance and need. Vital items are those which are essential to the functioning of the business, Essential items are those which are important to the functioning of the business, and Desirable items are those which are not essential but are desirable to have.
  • The ABC-XYZ method, which is a combination of the ABC and XYZ methods. This method divides inventory into six categories: A - those items with high value and high turnover, B - those items with high value and low turnover, C - those items with low value and high turnover, X - those items with low value and low turnover, Y - those items with moderate value and moderate turnover, and Z - those items with high value and high turnover.

In summary, the ABC method is a popular tool for inventory management, but there are several other methods which can also be used, such as the Pareto principle, the XYZ method, the VED method, and the ABC-XYZ method. Each of these methods has its own advantages and disadvantages, and it is important to consider which one is the most suitable for a particular situation.


ABC method — recommended articles
Pull system — Abc inventory classification — ABC analysis — Cost per unit — Costing system — Segment margin — Capacity analysis — Optimum size of the order — Stock turn — Best of breed

References

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