The ABC method of classifying inventory allows you to organize the distribution of various goods within the warehouse according to their importance to the business, their value and their turnover. This method prioritizes the acquisition and placement of products not by volume or quantity, but by the economic contribution they make to the company.
What is the ABC method for inventory classification?
The ABC method of classifying inventory allows you to organize the distribution of various goods within the warehouse according to their importance to the business, their value and their turnover. This method prioritizes the acquisition and placement of products not by volume or quantity, but by the economic contribution they make to the company.
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Definition of ABC inventory
ABC inventory is a classification method that is based on the Pareto principle and states that 20% of the products account for 80% of the value. In this sense, group A includes the most important products in terms of revenue and turnover, group B is somewhere in between and group C comprises the products of less importance in these respects.
Pareto Principle in ABC Inventory
The ABC method is based on the Pareto principle or the 80/20 rule, which states that 20% of your effort will account for 80% of your results. Applying this to the warehouse ecosystem, 20% of the items generate 80% of the movements in the facility, while 80% of the products generate the remaining 20% of the movements.
The idea behind the ABC method is that a company should focus on managing and controlling the most important products more efficiently and effectively, while allowing less rigorous control for less important products. Therefore, the ABC method focuses on identifying high turnover, high value products, as well as low turnover, low value products, so that informed and effective inventory decisions can be made.
The ABC method classifies products into three categories: A, B and C.
PRODUCTS OF CATEGORY A
In terms of quantity, they usually account for 20% of the inventory. However, they have the highest turnover and are therefore of strategic importance. A-products are the ones in which the business has invested the most money and which generate 80% of its revenue. It is therefore crucial to avoid stock-outs of these products.
This group also includes products that, due to their characteristics, are critical for the proper functioning of the business. In any case, it is advisable to maintain strict stock control over A products, with frequent or even perpetual inventories.
As for the location of A-goods in the warehouse, they are normally located in the lower areas, with easy and direct access for operators and close to the shipping docks.
PRODUCTS OF CATEGORY B
These make up the medium turnover range and generally represent 30% of inventory. As these goods are replenished more slowly, their value and importance count less than those of A products.
In this sense, it is necessary to pay attention to the trends of B products: they could make the leap to A rotation products or, on the contrary, become C products. Provisioning of this type of stock can be done according to the minimum/maximum stock level rule, rather than keeping strict control of purchases and issuing orders on a continuous basis (which may well be the case for A items).
In the facility, these B products are located in mid-height areas. They are not as directly accessible as A-products, but they are not the most inaccessible.
PRODUCTS OF CATEGORY C
As a whole, C products are the most numerous, accounting for 50% of the references in stock. However, they are also the least requested by customers.
Since they are not strategic items, the resources allocated to control these products may be more modest and their replenishment is usually adjusted through safety stock. In any case, it is a good idea to keep an eye on these goods so that they do not end up in an obsolete inventory with zero turnover. When it comes to C-products, the big question is: is it worth investing part of your budget in maintaining this type of stock?
Because these items are sporadically accessed, they occupy the highest and least accessible areas of the storage facility, as well as those furthest away from the shipping docks.
Benefits of the ABC method in inventory management
The ABC method of inventory classification offers a number of significant benefits in the management of a company’s stocks. These benefits derive from the appropriate allocation of resources and the efficient organisation of the warehouse according to the importance of each product. The main benefits of the ABC method in inventory management are detailed below:
Optimisation of available resources
By using the ABC method, companies can focus their resources more efficiently by prioritising the most important products. Group A, which represents 20% of the highest value products, receives special attention and a greater investment of resources. This maximises performance and minimises costs associated with the most business-relevant products.
Guaranteed supply of the most relevant products
The ABC classification facilitates purchase planning by allowing a clear view of the importance of each product. By knowing which products are the most relevant in terms of revenue and turnover, the company can ensure that it maintains an adequate stock level of these items and avoids stock-outs. This avoids lost sales and customer dissatisfaction.
Precise inventory control
The ABC method provides more accurate inventory control by classifying products according to their importance. Products classified as class A, having a higher value and turnover, require more exhaustive control. This implies a more rigorous management of the life cycle of these products, with more frequent follow-ups, stock reviews, and actions to avoid losses due to obsolescence or expiration. Accurate inventory control helps to reduce the costs associated with excessive or insufficient inventories.
Agility in locating fast-moving products
With ABC classification, the products with the highest turnover (class A) are strategically located in more accessible areas of the warehouse. This allows for greater agility in the reception, storage and dispatch operations of these products, which translates into improved efficiency and reduced response times. This facilitates workflow and minimises waiting times, which contributes to greater customer satisfaction.
Process for carrying out an ABC inventory in Excel
ABC inventory in Excel is an efficient way to classify products according to their importance in terms of consumption and value. Below are the steps to carry out this process:
Steps for ABC inventory classification
- Open a new spreadsheet in Microsoft Excel.
- Write the names of each SKU or product in the first column.
- Record the consumption value of each SKU in the second column, i.e. the number of units sold multiplied by their unit cost.
- Sort the data from highest to lowest based on the consumption value using Excel’s ‘Sort’ function.
- Calculate the cumulative percentage of the consumption value for each SKU. Divide the consumption value of each SKU by the total consumption value of all products and multiply by 100.
- Assign each SKU a category according to the cumulative percentage of the consumption value. For example, products representing the highest 20% will be classified as Class A, the next 30% as Class B and the remaining 50% as Class C.
- Highlight or colour the cells according to their category to make the sorting more visual.
How can I do an ABC analysis of my inventory?
You can perform ABC calculations on individual products, inventory groups and a wide range of inventory, and it can be calculated in just 5 easy steps.
- Step 1: Use the following formula to calculate the annual consumption value of each product: Annual number of units sold (per item) x cost per unit.
- Step 2: List all products in descending order according to their annual consumption value.
- Step 3: Add the number of units sold and the annual consumption value of the products.
- Step 4: Calculate the cumulative percentage of goods sold and the cumulative percentage of annual consumption values.
- Step 5: Divide the data into three categories. The division of the ABC categories will be unique to your company, but approximately 80%, 15% and 5%.
However, as we have discussed in other posts, nowadays in order to have a comprehensive inventory control it is essential to have a good warehouse management system, both for day-to-day management and to make strategic decisions, and thus be able to easily apply classification methods such as ABC.
