Time management is a make-or-breaker in scaling your operations. This is particularly true when it comes to scaling inventory. In order to reduce stockouts and cut inventory costs you need a way of prioritizing which inventory items have the biggest impact on total inventory costs. This is where ABC analysis can help you.
As you know, all goods are not created equal. Some goods cost more than others. Other goods might be used more frequently. ABC analysis helps you categorize goods so you know which ones to focus on for maximum impact.
Before we get to the ABC’s, let’s take a short trip to 1890s Italy to understand the core of this method. It’s based on the Pareto Principle or 80/20 rule, which originally stated that the richest 20% of the population control 80% of the wealth.
Setting aside the echoing familiarity of 19th century Italian land ownership, it means that roughly 20% of your inventory will make up 80% of your costs.
So with this in mind, your inventory can be separated into a hierarchy of 3 categories:
- ‘A’ goods are the items that make up roughly 20% of your inventory but consume 80% of your total inventory value. You don’t want to run out of this inventory, but you also cannot afford to hold unneeded inventory so it’s recommended that:
- Routinely cycle count this inventory, daily, or even continuously.
- Set up reorder points, desired inventory levels & lead times in Batchbud or whichever inventory management tool you use. That way you can get notified when you need to reorder.
- ‘B’ goods make up 30% of your inventory but are only 15% of your annual inventory value.
- You can afford to cycle count less frequently. Weekly or biweekly.
- ‘C’ goods make up about 50% of your inventory but only equate to about 5% of your annual inventory value.
- Since they have low unit cost you can afford to hold additional inventory, particularly if they don’t have an expiration date, for example gloves or salt.
- These items don’t need close monitoring and ordering can even be automated with tools like Batchbud.
- Cycle counting can happen periodically but at scale isn’t feasible on a weekly basis.
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These are the steps to determine which goods go into which categories. The free csv above lays out the columns & formulas for you:
- Multiply the price of your item by consumption volume for a year Item cost x amount used in a year = inventory value
- Do this for all your inventory items
- Sort your inventory value column from high to low
- Sum up everything in the inventory value column to get the total inventory value
- Find each item’s % of the total inventory value. So in the column to the right of the inventory value column calculate item’s inventory value / total inventory value
- Separate the inventory items into your ABC categories. Highest 80% as A’s, next 15% as B’s and all remaining items as C’s.
Why you should try this method
If you knew that spending time on 20 ‘A’ items had more financial impact on your company than monitoring 200 ‘C’ items, wouldn’t that be a better use of your time? The ABC method is a simple and effective time management strategy that will add hours back to your day.