ABC ANALYSIS – Advantages and Disadvantages

ABC ANALYSIS (ALWAYS BETTER CONTROL)

Any organization usually deals with lots of items. It is very difficult to exercise control over all the items. Controlling means transactions related to inventory, degree of control, type of records to be maintained, lot sizes, frequency of review, size of safety stock to be maintained etc.
ABC analysis helps to classify the thousands or even millions of individual items into three groups namely items belonging to A group, B group, C group items respectively. ABC analysis is done based on the Pareto’s principle.
Consumption value is the basis for ABC classification. Consumption value is the product of unit price and consumption.

Read more : ABC Inventory analysis

Mechanism of doing ABC classification:

Steps involved:
1. Collect previous year consumption and unit price for each item.
2. Multiply the consumption and unit price for each item to get the consumption value.
3. Rank the items corresponding to the consumption value.
4. Calculate cumulative consumption value against each item.
5. Find the percentage of cumulative consumption value.

Usually to classify the items into ‘A’ class there is leverage available. The leverage is 60 to 70 percentage of the consumption value.
This means the cut-off value can be fixed in between 60 to 70 percentage  of consumption and the corresponding items which contribute up to the cut-off value are classified as a class items.
Similarly, to classify the items into B class, there is a leverage of the consumption value to the extent of 10 to 20 percentage of the consumption value. To classify the items into C class, there is a leverage of the consumption value to the extent of 10 to 20 percentage of the consumption value.

abc percentage
abc percentage

Kinds of Control
Purpose of classifying the items into ABC is to control over each item. The degree of control required for A class is not same for B and C class items. The following table helps the material manager in the kind of control to be exercised on these items.

Advantages of ABC Analysis:

1. Better exercise of control over all materials.
2.The capital invested in inventory can be reduced to minimum levels.
3. Warehouse and storage costs can be reduced.

Limitations of ABC Analysis:

  1. ABC analysis mainly provides a guideline for inventory management. It needs to be supplemented by basic understanding and judgment as there are certain items which may fall into category C or category B due to their low usage value but are otherwise very critical for the production process of the firm. Their inventory levels have to be carefully monitored.
  2. The ABC analysis, to be effective, needs to be constantly undertaken and pe-riodically reviewed by the management, as the number of items and value of items keep on undergoing changes.
  3. The practical problem in the usage of ABC analysis is that generally, thousands of items fall in category C, as a result, a lot of time is spent on managing inventory of items of this category (even if it needs simple control). The time left for controlling the inventory stocks of categories A is therefore much shorter than that required for their effective management.
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