The first thing you need to do if you want to implement ABC analysis is analyze your current system to make sure it can handle operating with the ABC approach. If your system doesn’t currently allow you to prioritize some items over others, you may have to revamp your entire inventory management system—which can be expensive, time-consuming, and altogether frustrating.
To start using the ABC code, you’ll also need to ensure that you have accurate records on inventory cost and customer demand. Both cost and demand are important elements to determining each item’s usage value—without these details you won’t know which items to sort into category A and which to sort into category C.
It’s time to start figuring out how each of your products contribute to your business. Here’s how:
1. Determine the time period for your analysis. While many businesses opt to use annual consumption value (which analyzes the amount and cost of products sold within the past year), you could choose to look at sales for just the past month or quarter—the choice is yours.
2. Find the usage value of each item by multiplying the number of units sold by the total cost per item.
Usage value = units sold x cost per item
3. Calculate your total inventory value* by adding all the individual usage values for your products.
Total inventory value = product 1 usage value + product 2 usage value + etc.
4. Sort products (within your Excel spreadsheet or whatever tool you’re using) from highest usage value to lowest.
5. Calculate each item’s cumulative value by dividing the product’s inventory value by the total inventory value, then multiplying by 100. This should give you the percentage of your total inventory value that can be attributed to each item.
Cumulative value = (product inventory value / total inventory value) x 100
Keep in mind that while most inventory planners can calculate these values manually, any inventory management software that supports ABC analysis should be able to calculate these values for you automatically.
ABC analysis is loosely based on the Pareto principle, which basically says that the majority of any effect comes from a very small portion of the causes. Applied to ABC analysis, this means the bulk of your inventory’s total consumption value gets allocated to A items, while B and C items make up less of that value.
You can decide the precise percentage of inventory items and consumption value allocated to each category. But generally, your values should fall into the following ranges:
- A items: 10%–20% of your inventory, accounting for 60%–80% of your annual consumption value
- B items: 20%–30% of your inventory, accounting for 20%–30% of your annual consumption value
- C items: 50%–70% of your inventory, accounting for 5%–15% of your annual consumption value