How do you effectively manage different types of inventory for maximum profit and lowest cost?
You segment them into different categories, making it easier to track them and use your resources appropriately.
So what method can you use to sort your inventory?
The answer: an ABC analysis of inventory.
ABC analysis will help you view your inventory from the perspective of best-selling to least-selling, and lowest inventory costs to highest.
We’ll show you what an ABC analysis of inventory is, why it’s important, and what advantages your company can gain by implementing it.
What is ABC Analysis of Inventory?
ABC analysis of inventory is a method of sorting your inventory into 3 categories according to how well they sell and how much they cost to hold:
- A-Items – Best-selling items that don’t take up all your warehouse space or cost
- B-Items – Mid-range items that sell regularly but may cost more than A-items to hold
- C-Items – The rest of your inventory that makes up the bulk of your inventory costs while contributing the least to your bottom line
ABC analysis of inventory is one way of applying Pareto’s 80/20 principle. The bulk of your profits come from about 20% of your total inventory.
Now that you know what ABC analysis means, let’s see why should you bother using it.
What is the Purpose and Importance of ABC Analysis of Inventory?
ABC analysis of inventory allows you to separate your most important products from your least important ones so that you know which products deserve most of your resources and attention to help you boost your sales and net margins.
ABC analysis of inventory helps you keep working capital costs low because it identifies which items you should reorder more frequently and which items don’t need to be stocked often – reducing obsolete inventory and optimizing the rate of inventory turnover.
Now that you know why ABC analysis is beneficial to businesses, let’s see it in practice.
What is an Example of ABC Analysis of Inventory?
The basic principle behind ABC analysis of inventory is that not every product has equal value. Because of this, you need to sort your inventory according to its value. Here’s what this process looks like in practice:
Imagine you’re a medical supplier. For the sake of this example, you sell 3 products:
You decide to perform an ABC analysis on your inventory to understand what’s selling the best, the worst, and what costs the most to hold in your warehouse.
Although wheelchairs are the smallest part of your inventory, they make up the bulk of your sales, around 60%. They would clearly go into your A category.
Orthopedics make up about 30% of your sales, and even though it uses over half of your warehouse space, it would still go into category B.
Diagnostics carry the last 10% of your sales while taking up a fair amount of warehouse space, but since they provide the lowest profit margins, they go into category C.
Now that you have an understanding of why and how ABC analysis of inventory works, let’s look at a few of its advantages to your business.
What are the Advantages of ABC Analysis in Inventory Management?
ABC analysis of inventory helps you effectively forecast demand by splitting your inventory into categories that are based on customer demand.
Smarter Negotiations with Suppliers
After analyzing your inventory and sorting it into A, B, or C categories, you’ll know which products you should focus on buying at the lowest price, and which suppliers of those products you should negotiate with to bring their prices down so you can maximize your profit margins.
Since you know items in category A are your best-sellers, you may be able to raise the prices of those products for increased revenue.
What is One Tool You Should Use With an ABC Analysis of Inventory?
ABC analysis of inventory only works if you’re effectively tracking and monitoring your orders and sales.
Without clear insight into inventory KPIs and other metrics, you won’t be able to sort your inventory into ABC categories.
There is one tool, however, that will provide those data points:
And a really good cloud-based inventory management system will give you much more than just solid reports, it will allow you to batch track your inventory, streamline your stocktaking process, and help you achieve inventory management best practices.
Where will you find a good cloud-based inventory management system?
Right here at DEAR Inventory.