You will need a calculator for this tutorial.

ABC Analysis

The ABC Analysis is one of the most established analysis methods within business administration. The basis of the ABC Analysis is the experience that very often a small number of objects cause a high portion of e.g., expenses. Thus the e.g. products are arranged into three groups A, B and C. A typical arrangement is that the A products causes the highest portion of the expenses the B products hold a medium portion and the C products the smallest portion.

In supply chain, ABC analysis is an inventory categorization method which consists in dividing items into three categories, A, B and C: A being the most valuable items, C being the least valuable ones. This method aims to draw managers attention on the critical few (A-items) and not on the trivial many (C-items).

Splitting items in A, B and C classes is relatively arbitrary. This grouping only represents a rather straightforward interpretation of the Pareto principle. In practice, sales volume is not the only metric that weighs the importance of an item. Margin but also the impact of a stock-out on the business of the client should also influence the inventory strategy.

Activity:

Complete the ABC Table to classify the inventory control thresholds. Apply the following Thresholds:

Class A represent the first 80% (approximately) of value within inventory held

Class B represent the next 15% (approximately) of value within inventory held

Class C represent the final 5% (approximately) of value within inventory held

(Some inventory item may be between Classes. If so, make a judgement call in classifying the inventory item)

Steps in ABC analysis

Step 1) Multiply the Average Usage Quantity (Units) with the Unit Cost ($) of each item to calculate the Annual Usage ($) for each item. (Table 1)

Step 2) Based on the Annual Usage ($), rank the items. The item with the highest $ usage annually is ranked first. Then the next lowest annual usage item is then ranked second and then repeated until the lowest item is ranked last (Table 1). The item with the highest annual usage will be given a 1 within the Rank column.

Step 3) In Table 2, order the Rankings and Annual Usage ($) calculated in Table 1. The item with the highest Annual Usage ($) should be ranked number 1. The item with the lowest Annual Usage ($) should be ranked number 10.

Step 4) Calculate the Cumulative Annual Usage ($) for each item at each rank. For example, if the rank 1 item has an Annual Usage of 5000, the Cumulative Annual Usage will be 5000. If the rank 2 item then has an Annual Usage of 800, the Cumulative Annual Usage for the ranked item 2 will increase to 5800.

Step 5) Calculate the total Cumulative Annual Usage ($). This will be the Cumulative Annual Usage for rank item 10.

Step 6) Once the total Cumulative Annual Usage ($) is known, calculate the Cumulative Annual Usage Percentage for each item. For example, if the total Cumulative Annual Usage ($) is 1000 and rank item 3 has Cumulative Annual Usage ($) of 500. The percentage will be 50%.

Step 7) Based on this percentage value, categorise the items in A, B and C categories.

Use the following boundaries to classify the inventory:

Class A 80% (Items with a Cumulative Annual Usage Percentage 0-80%)

Class B 15% (Items with a Cumulative Annual Usage Percentage 80-95%)

Class C 5% (Items with a Cumulative Annual Usage Percentage 95-100%)

Table 1

Item #	Average Usage Quantity (Units)	Unit Cost ($)	Annual Usage ($)	Rank
1	17	2.5
2	50	17
3	15	15
4	25	17
5	5	17
6	50	119
7	153	5
8	21	2.5
9	19	2
10	15	2.5

Table 2

Rank	Item #	Annual Usage ($)	Cumulative Annual usage ($)	Cumulative Annual Usage (%)	Category assigned
1
2
3
4
5
6
7
8
9
10
	Total