ABC Inventory Method

Proper inventory management has never been more critical than in today's financial climate. Too much inventory of the wrong item can result in obsolescence and a major hit to the company's bottom line. Not enough inventory, and the result is lost sales, poor customer relations and added cost to expedite shipments and sooth customer relations. In order to properly manage your inventory you must properly classify your inventory. This is done using the ABC inventory method.

This system breaks down all inventory into three categories labeled either A, B, or C. Most companies find they are subject to the 80 - 20 rule. Eighty percent of their sales came from 20 percent of inventory items. This leaves 80 percent of inventory items to account for only 20 percent of sales. With this data it becomes clear all inventory is not created equally.

The 20 percent of items which make up 80 percent of all sales will be classified as A items. Inventory which is considered obsolete or which is nearing obsolescence status will be classified as C items. Everything in between these two will be classified as B. This is a general guideline and will be subject to change based on the individual needs and make-up of your company.

Items with a very high inventory value, or with very long lead times may be moved up to an A classification in order to more closely monitor their status. Items for which there are substitutes or perhaps multiple vendors may move down in classification. The important thing to remember is that the system must be flexible. Items may move from one classification to another based on a variety of variables. Labor disputes, raw material shortages, and natural disasters are just a few of the things which can dramatically affect inventory and inventory availability.

An ABC inventory system will generally use a cycle count inventory management system. With a cycle count system, a percent of inventory is counted monthly rather than having an annual physical inventory. A classification items would be counted more often, perhaps monthly if feasible. B classification items can be counted quarterly, and C classification items counted annually. By counting inventory more frequently mistakes and variances are discovered more rapidly and can be dealt with in a more real time scenario. It can be very difficult to determine the root cause of a problem which took place eleven months ago. A problem which developed last week is far fresher and far easier to investigate. Once the root cause is determined, corrective active can be implemented to prevent a repeat of the error.

Inventory, be it on a pallet rack in the warehouse or a retail shelf, is in reality cash which has been temporarily converted into an inventory unit and hopefully will soon be converted back into cash. The time between these two conversions is critical and must be managed properly and with a proactive and aggressive approach.