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ABC (Always Better Control ) analysis

This technique involves the classification of inventory items
into three cvolume ategories A, B and C according to their
annual cost consumption (unit cost x annual consumption).
Although the break points between these groups vary
according to individual business conditions, a common
breakdown might be as follows:
The ABC analysis is based on Paretos law (80-20 rule) that a few
high usage value items constitute a major part of the capital
invested and having low usage value constitute insignificant part of
the capital.
Category Percentage of the item Percentage of the total annual valu
(or group) Value of the inventories (Rs)

A 10-20 70-85
B 20-30 10-25
C 60-70 5-15
The ABC analysis facilitates analysis of yearly consumption value of
items in the store to identify the vital few items that are generally
referred to as A category items which are also vital from the financial
point of view and require careful watch, scrutiny and follow-up.
In ABC analysis the items are classified in three main
categories based on the respective usage value :
Category A items
More costly and valuable
Have large investments but not much in number
(e.g. 10% of items accounts for 75% of total capital invested
in inventory)
More careful and closer control is needed
Ordered frequently but in small number
Top inventory staff controls the items
Have high carrying cost
Frequency orders of smaller size results in enormous saving
A periodic review policy is followed to minimize the
Category B items
Having average consumption value
( e.g. nearly 15% of the item in an inventory account
for 15% of the total investment)
Have less importance than A class items but are
much costly to pay more attention on their use.
Requires lesser degree of control than those in
category A
Category C items
Having low consumption value
(e.g. nearly 75% of inventory items account only for 10% of
the total invested capital )
Such items can be stocked at an operative place where
people can help themselves with any requisition formality.
Can be managed in a little casual manner
For these items, a fixed-order quantity system might be
The order quantities can be relatively large without incurring
excessive costs
A large reserve stock can also be maintained

Important Points of ABC Analysis
Whenever the items can be substituted for each other they
should preferably be considered as one item.
More emphasis should be given to the value of consumption
and not to the cost per unit of item.
While classifying as A, B and C all the items consumed on the
organization should be considered together instead of
considering them like spares, raw material, semi-finished and
finished items and then classifying as A, B, C.
The period of consumption necessarily be one year.

Limitations of ABC Analysis
If ABC Analysis is not updated and reviewed periodically, the
real purpose of control may be defeated. For example C
category items like diesel oil in the firm will become most
high value items during power crisis and therefore should
require more attention.

The periodic consumption value (not the unit value) is the
basis for ABC classification.
The application of ABC analysis extends overall of
the aspects of material management like
purchasing, inventory control, value analysis etc.
STEP 1: Determine the number of units sold or used in
the past one year of period.
STEP 2: Determine the unit cost for each item.
STEP 3: Compute the annual usage value in Rs. ($) of
each item consumed as follows:
Annual usage value = annual requirement x
per unit cost
STEP 4: Arrange the items in a descending order according
to their respective usage value computed in step 3.
STEP 5: Express the annual value of each item as
percentage of the total value of all items.
Also compute the cumulative percentage of
annual consumption value spent.
STEP 6: Obtain the percentage value for each of the
items. Also cumulate these percentage values.
STEP 7: Draw a graph between cumulative percentage
of items (on x-axis) and cumulative annual
percentage of usage value (on y-axis) and mark
cut-off points where the graph changes slope.
Example 1:
A company produces a mix of high technology products
use in hospitals. The annual sales data are as follows:

Product Type Number of units Unit Price (Rs)
1 1000 2.50
2 250 0.55
3 150 6.50
4 300 1.00
5 100 1.50
6 700 1.43
7 500 7.00
8 15 4.98
9 1000 0.75
10 600 1.62
11 25 33.00
12 4 15.50
13 1000 5.00
14 2850 2.50
15 10 0.83
16 355 0.98
17 50 1.37
18 393 1.85
For inventory control reasons, the company wants to classify
into three groups A, B and C, on the basis of annual sales value
of each item. You are assigned the task of helping the company.
Example 2:
Usage-Cost Data for 20
Inventoried Items
ABC Analysis Calculations

ABC Analysis Example