ABC Analysis in Inventory Planning

An ABC Analysis is an inventory categorisation method whereby an organisation’s inventories are categorised in three categories, varying from the most valuable to the least valuable. The analysis is based on Pareto’s law (the 80/20 principle) whereby the assumption is that only 20% of activities (or then of inventory) drive 80% of the value created in an organisation. Pareto is also sometimes used to categorise activities, inventory or other organisational valuables.

Let’s assume that a small company has a total of twenty (20) items on inventory. Particulars are as follow:

Where must this company focus its attention to prevent losses and ensure the most cost-effective use of its resources? The answer is on its most valuable inventory items. In the example, these are as follow:

This inventory categorisation system is important for the management of inventories, and for cash flow purposes. If you develop a warehouse or a related inventory control system, it is important to know where to place the focus. Items in the A-category of inventories must be prioritised when it comes to loss control and issuing measures.

Another important consideration when deciding to use the ANC Analysis, is cash flow forecasting. When extensive orders must be placed, it is important to make sure that your business has the required capital available in the bank in the month when the payment must be made. The ABC inventory categorisation system enable you to identify those limited number of inventory items that are the main cost drivers.

A cost driver is a transaction that consumes a substantial portion of available cash (cost). It is important for start-up businesses to do proper purchasing planning, linked to cash flow consideration, because there may be months (cash flow periods) that you simply will not have the required cash in the bank for such purchases.

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