What
if there was a system of Inventory classification that you could use to
maximize the effectiveness of your efforts in just about any aspect of your
business especially inventory management?
The
good news is that such a system was developed a long time ago. Originally based
upon an observation by Italian economist Vilfredo Pareto, and now known by many
terms such as the Pareto Principle, 80/20 rule, ABC analysis and ABC Classifications.
As
the diagram below shows, in a typical organization a small % of customers (A)
often generate a large % of the sales eg 80%. By contrast, a large number of
customers (C) often generate only a small % of sales eg as low as 5%.
The
same logic applies to Inventory valuation where often a small % of the items
represents a large % of the inventory valuation and a large % of the items
represents a small % of the inventory valuation.
If
one could easily identify the customers that generated the most sales and the
items that represent the highest inventory investment, wouldn’t that help you
to increase sales and reduce inventory?
The
main idea here is that the real value of an ABC Inventory Management system is more
than just a classification system. Rather, its true importance is that it will
help you to understand how effective the major systems in your business really operate,
ata practical level.
Consider This:
In
terms of inventory management, the impact is obvious: the traditional methods
of inventory management are grossly inefficient because with a little bit of
analysis you will often find that:
While 20% of your
Items represent up to 80% or so of your inventory valuation you are probably
managing all your items the same way – eg using the same inventory replenishment
technique
So
you have to ask yourself the question “how should I manage the 20% of my items that
accounts for approximately 80% of my inventory valuation, and how should I
manage the 80% of items that represent only 20% of my inventory valuation”?
What would be the Quantifiable Benefits of better Inventory Management?
Lets
assume you can reduce your inventory by 10% (a very realistic target with ABC
inventory classification type techniques)
If
your inventory valuation is $20million you could a achieve:
A
once off saving of $2 million (10% of $20m) – straight into your Bank account
A
saving each year of $200,000 (10% of $2m) – assuming a ‘holding cost’ of 10%
again very conservative
Certainly worth
spending your time and effort on – don't you think?
Imagine
what your boss would say if you came up with these savings, that promotion
would be a lot closer and your standing in the company would improve.
So how do you calculate and assign what’s known as ABC classification codes?
Its
simple, and with a well-designed inventory spreadsheet it makes it even easier.
Firstly,
calculate the 12 month dollar usage for all of your products (Note: there are
other selection options). You can do this by multiplying your volume sold or
used pa by the unit cost of that item.
Next,
rank your items in descending order of annual dollar usage.
Then,
calculate a cumulative % of the annual $ usage
Then,
calculate a cumulative % of the number of items
From
there:
Assign
“A”to all items that comprise the top 80% of your inventory investment
Assign
“B” to all items that comprise the next 15%.
Assign
“C” to all items that are in the bottom 5% of your inventory investment
What do you do when you have assigned the ABC classification codes?
In
inventory management, there are many usages that the ABC classification can be
used for including:
Applying
different degree of control to each item according to their classification such
as:
- Re-order frequency (“A” –daily/weekly, “C” - monthly)
- Cycle count frequency (“A” - weekly, “C” every 3 months)
- Safety stock levels (“A” lower, “C” higher)
- Re-order quantities (“A” weekly, “C” items monthly)
All
these actions combined to reduce the total inventory $ invested and will free up
your time by spending less time managing the “C” items and allowing you to
spend more time on the “A” items –where the most $ savings are.
What are the Benefits to you?
Lets
assume you achieving significant inventory $ savings by introducing a ABC Inventory Management system in your organization what will be different for you?
- Your boss will look up and listen
- You will stand out from the crowd as someone that has the company at heart and gets things done
- Your day-to-day working life easier by being better organized with a clearly defined logic to your inventory planning processes
- You will have more time to focus on what really matters (the “A” items)
- That job promotion will be looking a lot closer
Remember with New Skills your Future Starts Now
Conclusion
Businesses
that ignore the ABC system of classification are not operating as systematically
or at an efficiency level that is possible. There is a lot of money to be saved
in reduced inventory levels and improving customer service though better inventory
analysis and planning using an ABC Inventory Management system.
