When it comes to inventory control, many businesses use ABC analysis to effectively categorize their inventory and determine what products require the most stringent inventory control efforts. After all, inventory control is all about stocking just enough inventory to not run out—while never wasting money on items you just don’t need yet.
In this article, we’ll define ABC analysis and outline how to conduct an ABC analysis of inventory so you know where to focus your best inventory control efforts.
What is ABC analysis?
ABC analysis is a popular inventory management strategy that helps businesses identify essential items they keep on hand. This allows those businesses to apply their tightest inventory control methods—and best record-keeping efforts—to the most crucial inventory. As the name suggests, ABC inventory analysis breaks down your business’s inventory into three categories: A, B, and C—with A being the most vital.
How to conduct an ABC analysis of inventory
Ready to apply ABC categorization to your business’s inventory? Use these five steps to move through the process.
Step 1: Get your inventory records in order
Before you even begin to practice inventory control, you’ll need to make sense of your inventory records. Whether you’ve been using a sheet of paper, an inventory spreadsheet, or an inventory app to keep track of your inventory, you’ll need to review that data to categorize your inventory properly. Do the best you can to make sense of the numbers, and know that as you begin to practice more optimal inventory control, you’ll also learn to keep better records that’ll make this process easier next time.
The point of getting these inventory records straight is simple. You need to figure out what inventory is most important to your customers—and what inventory is responsible for bringing in the most profits for your business. In other words, you’ll be rifling through old data to forecast demand. But, once you’ve done the hard work, you’ll learn exactly what items require your most concerted inventory control efforts.
Step 2: Review consumption or sales
When pulling inventory reports, think about just how long a timeframe you’d like to consider. If your business is cyclical, annual may work. If your business is seasonal, quarterly may be best. And if your business is unpredictable, you might want to review several years of inventory records, matching the ebbs and flows of your sales with external factors, like the economy, the weather, and so on.
Many businesses look to key metrics like sales or consumption during this practice, but there are other options. Total sales, gross margin, purchasing costs, holding costs, or any other metric you choose are fair game. Whatever you decide, ensure that the metric effectively measures the consumption value of your inventory over a given period of time. You know your business best.
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Now that you have your inventory records all ready to go, you can conduct your ABC analysis of inventory.
Remember, there are limitations to ABC analysis. The chart above—and the Pareto Principle, as a whole—are merely suggestive. The framework is meant to be just that: a template that helps identify which items are most vital to your business and require the most stringent inventory control efforts. If you can identify the 10% to 20% of your inventory that meets that criteria, you’re off to a great start.
Step 4: Create a standard operating procedure
Now that you’ve categorized your inventory, you’ll need to create a system that allows you to keep up your inventory control efforts for longer than just a couple of weeks. To do this, you’ll want to create a standard operating procedure (SOP) that outlines:
Precisely how inventory is managed and tracked (document, spreadsheet, or app)
How inventory is checked in and out, and what kind of documentation is required
How inventory will be counted and reordered
How and how often your business will reevaluate ABC classification based on new records
You’ll need to create SOP systems for all three categories of your inventory: A, B, and C. That’s because your business never wants to run out of Category A items—a stockout could be devastating, either causing a work stoppage or sending your customers to another company that can meet their demands sooner. But you’ll have a totally different strategy for Category C, where a stockout might be annoying, but by no means catastrophic.
Knowing this, tailor your SOP to reflect your business’s budget, cash flow, profit margins, storage space, lead time, proximity to suppliers, and more. And don’t be afraid to bring different voices from your business together to carve out the best strategy possible.
Step 5: Continue to refine your inventory control strategy
Your SOP will help detail exactly how your business plans to keep its inventory control strategy accurate. While some businesses don’t see many changes in what they sell year after year, others do. If you work in an industry that’s volatile or even affected by changing tastes and trends, you’ll want to conduct ABC analysis more frequently than a business that sells tires or umbrellas.
Many businesses find that by upgrading to inventory management software, they can keep an eye on their inventory no matter what’s going on. This is because when businesses keep perpetual inventory, your team will always have a pulse on current inventory levels, including unanticipated fluctuations that are beginning to turn into bonafide patterns.
Inventory software can also streamline inventory counts and audits, make it easier for your team to check items in and out, and help you keep an eye on other ways your business might burn cash, including inventory shrinkage and obsolescence.
What are the benefits of ABC analysis?
There are many benefits to ABC analysis, which is why so many businesses across very different industries use some version of the ABC analysis inventory control technique to manage their stockrooms. Here are four of those benefits:
1. Better inventory control, especially where it matters most
When your business practices ABC analysis, it’s choosing to take a closer look at how it spends cash—and on what. Simply by getting those records in order and taking a long, hard look at your team’s spending, you’ll begin to get a better handle on both inventory management and cash flow.
Then, once you’ve implemented a standard operating procedure for your inventory control strategy, you’ll reap even more benefits. The most important? Always having enough of your most important inventory in stock—without tying up cash (and other resources) on the little things that matter a whole lot less.
2. A great opportunity to revisit pricing and review profits
Another perk of ABC analysis? You’ll find that as you take a closer look at your most vital, profitable pieces of inventory, there could be some new ways of boosting profits. Perhaps you’re undercharging for items or realize you’re spending way too much ordering something from an old supplier. While you’re sifting through those records, new and meaningful ways to increase revenue or decrease spending may reveal themselves.
3. Improve demand forecasting
To practice solid inventory control, you have to sit down and forecast demand for your inventory. Many people find that by practicing ABC categorization, the data acquired helps them forecast demand with even more accuracy. And the more accurate your demand forecasting, the better your bottom line.
4. A perfect way to get started with inventory control
ABC analysis is considered one of the best ways for businesses to dip their toes into the valuable science of inventory control. So if keeping track of every last item in your company’s inventory feels overwhelming, sitting down and applying this analysis to your inventory could make a lot of sense.
Don’t feel guilty about beginning only with your Category A inventory. You’ll learn a lot in the process—and hopefully discover that getting organized, especially with the right systems and tools in place, actually makes inventory management easier, not harder.
Sortly is a top-rated inventory management software solution that works on equipment your team already owns: laptops, smartphones, and tablets. Sortly can help you streamline your inventory control efforts so that your inventory records are always accurate—making ABC analysis that much easier. And once you’ve categorized your inventory, Sortly can help you put your inventory control strategy into practice with lightning-fast automation features like barcode and QR code scanning, low stock alerts, and customizable reports perfect for everything from categorizing inventory to auditing to reordering.