Describe what is meant by ABC analysis. What is the purpose of this inventory technique provide an example.
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Understanding ABC Classification
Class A items are the one that gets managements utmost focus and attention. The A, B and C classification of items has generally been based on a single criterion (Colley et al. 1977), i.e. money value per unit multiplied by usage rate (Silver and Paterson 1985). There are other criteria, however, that represent important considerations for management depending on the nature of the organization such as: Consumption rate, Demand, Lead-time, and Criticality of items (Bhattacharya et al. 2001).
The conventional ABC classification system is intended for grouping items of a manufacturing firm according to annual sales volume. The conventional classification technique is an attempt to identify the small number of items that will account for most of the sales volume, and that are the most important, in order to control for effective inventory management (Arsham 2005).
ABC analysis categorizes an organizations inventory items into groups depending on their relative values. The conventional way to classify the items is to forecast the total annual outlay for each stock item. The total annual monetary value of the items must be estimated by applying an average cost per item to the forecast production requirements for material, parts, and components. The items are then ranked depending upon their annual costs and classified into three groups.
