ABC analysis underlines a very important principle “Vital few: trivial many”. Statistics reveal that just a handful of items account for bulk of the annual expenditure on materials. These few items called “A” items, therefore, hold the key to business. The other items, known as “B” and “C” items, are numerous in number but their contribution is less significant. ABC on the basis of their annual usage. The categorization so made unable one to pay the right amount of attention as merited by the items.
A-Item: it is usually found that hardly 5-10% of the total items account for 70-75% of the total money spent on the materials. These items required detailed and rigid control and need to be stocked in smaller quantities. These items should be procedure frequently, the quantity per occasion being small. A healthy approach however, would be in to enter into contract with the manufacturers if these items and have their supply in staggered lots according to production programme of the buyer. This, however, will be possible when the demand is steady. Alternatively, the inventory can be kept at minimum by the frequent ordering.
B-Item: these items are generally from 10-15% of the total items and represents 10-15% of the total expenditure on the materials. These are intermediate items. The control on these items need not be as detailed and as rigid as applied to C items.
C-Items: these are numerous (As many as 70-80% of the total items),
Inexpensive (represent hardly 5-10% of the total annual expenditure on materials) and hence insignificant (do not require close control) items. The procurement policy of these items is exactly the reverse of A items. C items should be procured frequently and in sufficient quantities. This enables the buyer to avail price discounts and reduce work load of the concerned department.
Conducting ABC analysis
To conduct ABC analysis, following steps are necessary:
a) Prepare the list of the items and estimate their annual consumption (units).
b) Determine unit price (or cost) of each item.
c) Multiply each annual consumption by its unit price (or cost) to obtain its annual consumption in rupees (annual usage).
d) Arrange items in the descending order of their annual usage starting with the highest annual usage down to the smallest usage.
e) Calculate cumulative annual usages and express the same as cumulative usage percentage. Also express the number of items into cumulative items percentage.
f) Graph cumulative usage percentages against cumulative item percentages and segregate the items into A, B and C categories.
g) Decide the policies of control for the three categories.
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