Meaning, Benefits and Drawbacks of ABC Analysis

ABC analysis is a widely used inventory management technique that categorizes inventory into three groups: A, B, and C, based on relative importance.

This method helps businesses prioritize their inventory based on its importance and significance, leading to several benefits.

Also referred to as “Selective Inventory Control.” Strategies based on an ABC analysis:

• A ITEMS: stringent control and precise records
• B ITEMS: less stringent controls and excellent records
• C ITEMS: minimal controls and minimal documentation

The ABC analysis is a frequently employed inventory categorisation technique in which accuracy and control decrease from A to C. Some materials may be consumed in smaller quantities but for an extended time. These resources are stored in the group “A.” Similarly, certain materials may be consumed in big amounts but have reduced worth. These materials are stored in category C. In between these two extremes, certain items may be consumed in moderate quantities at moderate prices.

The ABC analysis provides a method for identifying items that will have a significant impact on overall inventory cost, as well as a method for identifying different stock categories that will require distinct management and controls.

The benefits of ABC analysis are that it can help managers make better decisions about inventory and allocate resources more efficiently. It can also help identify areas where cost savings can be made.

Benefits of ABC Analysis

The following are some of the advantages of ABC analysis:
a. Investment reduction: In ABC analysis, items under group “A” are purchased in the smallest possible quantity practicable. Attempts are also made to shorten delivery time. These, in turn, help in bringing down material investment. It can help business houses save some expenses, as it will buy only the most needed items. Secondly, it can help businesses keep track of their stock and make sure they have available the item when required. Finally, it will help the companies make long-range plans to ensure that they have the right mix of inventory.

b. Strict control: Under ABC analysis, it will be possible to apply strict supervision on more valuable materials in group A. This is because companies, being able to identify the most valuable items in stock, can identify what it is that each must have in terms of optimum levels of inventory about those products so as not to be surprised by increases in demand.

c. Minimum storage costs: as materials from group ‘A’ are purchased in the smallest quantities possible, the storage costs are minimised as well.

d. Time savings: as a significant effort is made to manage the material from group ‘A,’ it also helps to save time.

e. Efficiency: By implementing the ABC method to control the flow of items in and out of a warehouse or distribution centre, companies can avoid overstocking in the supply of the items and reduce the likelihood of them running low

Limitations of ABC Analysis

The drawbacks of ABC analysis are that it can be time-consuming and expensive to implement, and it may not be suitable for all businesses. It can also create a sense of employee competition, which can lead to conflict. Other limitations are discussed below:

• An ABC analysis will be ineffective if the materials are not appropriately divided into groups.
• It is not ideal for organisations where material costs do not fluctuate dramatically.
• There is no scientific basis for classifying substances according to ABC analysis.
• Classifying the resources into distinct groupings may incur additional expenses. Consequently, it may not be appropriate for a small organisation.

Conclusion

The ABC analysis categorizes products in three categories: A, B, and C. Category A are high-value products that consist of a very few number items comprising a small percentage of the stock with significant revenue contribution. Category B consists of mid-range products where value is moderate and contributes to a moderate portion of revenue. Category C consists of low-value products that contribute the least to revenue but consist of a large number of items in stock. The above classification of inventory can focus management on the most critical items.