What is ABC Analysis? Table of Contents What is ABC Analysis? ABC analysis is the process of classifying the inventory into A, B and C classes based on their relative significance to business, either by their monetary value, utilization, carrying cost or any other factor. This allows leaders to allocate the company’s resources to maximize the efficiency. https://www.ascent365.com/wp-content/uploads/2025/03/bf463f6f-eb9f-4259-bf9e-f80048d3_3400.mp4 Class A: Very important for an organization. High value, so tighter control, accurate records and frequent valuation required. Small (5-15) % of items account for Large (65-80) % of the value (consumption, costs, activity, etc. Class C: Is not critical for company’s operations. Comparatively low value so management will not lose sleep on the accuracy of inventory. Large (80+) % of items account for a relatively small (<15) % of the inventory value/consumption. Class B: Essentially in between classes A and C. Value at par with quantity. There is no fixed or globally followed percentage or factor. Every business can do it differently, and in fact with sophisticated ERP systems, can do the classification on multiple factors and report/track simultaneously. How is ABC Analysis applied? Inventory planners can forecast the demand and manage the appropriate stock levels, in order to minimize carrying costs and avoid obsolete / low-demand (dead) stock. Companies can prioritize having quality trade agreements with suppliers on Class A items, at the best possible combined costs (item costs, shipping costs, services, quality, RMA, etc.). Optimize inventory by stocking up on popular/high-demand items and reducing stock of slow-moving items. Reducing the risk of running out of stock or plant slowdowns. Effective utilization of working capital. ABC classification can be applied to better understand the impact of price updates on margins. Continuous process improvements using periodic tracking and refinement of classification is important. The leadership can then prioritize resources for optimizing Class A items compared to doing the same for Classes B or C. For example, cycle counting. Enable informed stock replenishment decisions on changing the safety levels, etc. Introduction to Inventory Control Every business has a need to optimize their inventory and supply chain, and many times than not, it is a constant challenge. A proper inventory control helps organizations to manage the business uncertainties and fluctuations. Furthermore, as the cost of inventory is a sizable portion of working capital, organizations employ various inventory controlling techniques for effective utilization of available resources with minimal risk to business. In the advent of modern inventory control techniques, organizations can control the inventory better. Applying such control techniques require vigor and most often being smart with classification of items, especially when dealing with hundreds to sometimes few thousands* of items. The inventory control techniques are applied selectively/discriminately to items. The inventory is classified based on its importance and specific inventory control is applied to each class, thus, optimizing the effort to manage large number of items. If you have few thousands of items, there is usually a better option to use item variants or dimensions, to optimize your item list. The most common and very widely used classification is the ABC classification, to classify items based on its relative importance to business, i.e. based on monitory value, availability of resources and carrying cost. The Law of Vital Few ABC classification uses the Pareto’s principle, popularly known as ‘the 80–20 rule’, also referred as ‘the law of vital few’. The law states that for many events, roughly 80% of the effects come from 20% of causes. When applied to inventory, the same is interpreted as 20% of the items may account for 80% of total cost in the given period. A sample diagram represents the classification of items based on inventory investment. It can be noted that 10% of items contribute to 70% of inventory investment, which is termed as the ‘significant few’ or otherwise called the A-class items. The next 20% of items that contribute the 20% of investment are termed as B-class items. The rest 70% of items, the major portion of items, contribute just 10% of inventory investment, which can be termed as the ‘insignificant many’ or C-class items. Thus, the classification provides the opportunity to apply different rigor but appropriate control techniques to respective class of items. While the A-class items deserve tightest control and most frequent review, B-class items can be put into medium level of control. C-class items can be managed through the simple rule of thumb. The sample used here is 70-20-10, and this ratio varies by organization. Benefits of ABC Analysis The classification of items into A, B& C yields many tangible and intangible benefits to the practicing organization. Smarter management of working capital: ABC analysis leads to The classification of items into A, B& C yields many tangible and intangible benefits to the practicing organization. A smarter management of working capital to manage optimal on-hand inventory and safety stocks, based on the consumption pattern and lead-times. Item replenishment policies can be derived from ABC analysis. Better Planning and forecasting: The ABC analysis help the planners to be more precise and effective in their demand and consumption forecasts. Wiser negotiations with vendors: With the insight of the vital few and insignificant many, negotiations with vendors become more wiser for price, lead time and delivery. Strategic pricing: Product pricing gets a shot in the arm as the analysis identifies the ‘vital few’ for profits and sales revenue. Marketing strategy and selling techniques could be revised based on the item classification to maximize revenue and profits. Optimized physical verification: Physical verification of stocks based on ABC classification helps organizations to effectively utilize organizational resources. While high value ‘vital few’ items could be checked more frequently, the low value ‘insignificant many’ can be checked seldom. There is a flip side to ABC classification that skips the cost of shortage or the effect of an item going out of stock, which is managed through the VED (Vital, Essential, Desirable) analysis. Frequency of the movement of an item is omitted in ABC classification, which is covered under FSN (Fast, Slow, Non-moving) analysis. How to use ABC classification? ABC analysis is usually running on 4 different parameters/factors of … Read more