ABC Analysis: A Business Technique for Inventory Management and Cost Prediction, Study notes of Accounting

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ABC ANALYSISABC ANALYSIS

(INSIDE OUT) (INSIDE OUT)

WHATS THIS????WHATS THIS????



ABCABC analysisanalysis isis aa businessbusiness termterm

used used toto definedefine anan inventoryinventory

categorization categorization techniquetechnique oftenoften

used in materials management. used in materials management.



InIn accounting,accounting, ABCABC standsstands forfor

activity-based costing. In inventory activity-based costing. In inventory

or or stockstock management,management, it'sit's aa

method of stock control. It's basic method of stock control. It's basic

assumption is that not all stock is assumption is that not all stock is

equally valuable, therefore doesn't equally valuable, therefore doesn't

need the same kind of attention. need the same kind of attention.

ABC CODES:ABC CODES:

When carrying out an ABC analysis, When carrying out an ABC analysis,

inventory items are valued (item cost inventory items are valued (item cost

multiplied by quantity issued/consumed multiplied by quantity issued/consumed

in period) with the results then ranked. in period) with the results then ranked.

The results are then grouped typically The results are then grouped typically

into three band. These bands are called into three band. These bands are called

ABC codes. ABC codes.



"A class" ---->80% of total value, or 20%"A class" ---->80% of total value, or 20%

of total items. of total items.



"B class" ---->15% of total value, or 30%"B class" ---->15% of total value, or 30%

of total items. of total items.



"C class" ---->remaining 5%, or 50% of"C class" ---->remaining 5%, or 50% of

total items. total items.

Lets take an example of television,Lets take an example of television,

->Picture tube or CRT is the major part, ->Picture tube or CRT is the major part,

contributing up to 70% of total cost but in contributing up to 70% of total cost but in

quantity it is only one set or piece. quantity it is only one set or piece.

So it comes in A class. So it comes in A class.

->In B class other products like monitor, ->In B class other products like monitor,

speaker parts, outer frame etc, contributing speaker parts, outer frame etc, contributing

up to 20% of total cost and in qunatity wise- up to 20% of total cost and in qunatity wise-

around 20% of total parts. around 20% of total parts.

->In C class, other minor parts like screws, ->In C class, other minor parts like screws,

wires, circuit boards etc, contributing the wires, circuit boards etc, contributing the

remaining 10% of cost and in quantity wise remaining 10% of cost and in quantity wise

70% of parts. 70% of parts.

How it is used in inventory How it is used in inventory management? management?

->The holding and carrying cost for the A ->The holding and carrying cost for the A

class products are very high and also if the class products are very high and also if the

When and why to use it?When and why to use it?

The ABC analysis can be be useful in several steps of The ABC analysis can be be useful in several steps of the the Sourcing Value Chan: Sourcing Value Chan:  (^) Demand Identification, to gather the annual spendDemand Identification, to gather the annual spend of a site of a site  (^) Demand Aggregation, to gather the annual spend ofDemand Aggregation, to gather the annual spend of several sites several sites  (^) Opportunity Assessment, to identify leveragingOpportunity Assessment, to identify leveraging opportunities opportunities The ABC tool is used to identify the “vital few” from The ABC tool is used to identify the “vital few” from the “trivial many”, according to a defined set of the “trivial many”, according to a defined set of criteria. criteria. Different decisions may be taken from the result of Different decisions may be taken from the result of the ABC the ABC analysis analysis

 (^) The basic utilization of the ABC analysis for aThe basic utilization of the ABC analysis for a buyer is to use it with the spend as a criterion. buyer is to use it with the spend as a criterion.  (^) It helps the buyer to identify the few AIt helps the buyer to identify the few A segments which will require special attention segments which will require special attention due to the “large amount of money” they due to the “large amount of money” they represent. A small “mistake” in managing the represent. A small “mistake” in managing the few A segments may cost a lot to your company. few A segments may cost a lot to your company.  (^) The C segments will require a differentThe C segments will require a different approach approach to simplify the administrative burden to handle to simplify the administrative burden to handle them. them.

1st step – Identify the1st step – Identify the objective and the analysis objective and the analysis criterion criterion 

the objective isthe objective is

clearly understood clearly understood



Our objective is toOur objective is to

generate savings generate savings

on on

the price of the the price of the

different different

equipments, by equipments, by

renegotiating renegotiating

existing contracts existing contracts

undertake purchasing category, classified by annual spend. maximum savings are generated which equipment segment should be considered for renegotiation efforts

2nd step – Collect data about2nd step – Collect data about the analyzed population the analyzed population Collect the data necessary to carry Collect the data necessary to carry out the out the analysis analysis  different safety equipments, anddifferent safety equipments, and  corresponding annual spendcorresponding annual spend

3rd step – Sort out the list by3rd step – Sort out the list by decreasing impact decreasing impact Sort out the list of equipment, in Sort out the list of equipment, in decreasing decreasing order,according to our criterion of order,according to our criterion of analysis,i.e. analysis,i.e. annual spend. annual spend.

DECRESING ORDER OF ANNUAL SPEND

5th step – Identify by classes5th step – Identify by classes

REQUIRED RESOURCESREQUIRED RESOURCES

An ABC analysis requires directionally correct An ABC analysis requires directionally correct

data. It relies on the availability of systems data. It relies on the availability of systems

allowing measurement of the criteria chosen allowing measurement of the criteria chosen

for for

the analysis. the analysis.

This availability of data becomes critical This availability of data becomes critical

whenever whenever

the population on target is spread over the population on target is spread over

several sites, countries, etc., or worse, is not several sites, countries, etc., or worse, is not

coded in a homogeneous way. Sometimes, a coded in a homogeneous way. Sometimes, a

conversion of data using product standard conversion of data using product standard

codes is codes is

mandatory. mandatory.

PROS AND CONS----PROS AND CONS----