ABC Analysis and stock levels

Mr. Rahul Anand

• ABC analysis is a type of analysis of material dividing in three groups called A-group items, B-Group items and C-group items For the purpose of exercising control over materials. Manufacturing concerns find it useful to divide materials into three categories.

• An analysis of the annual consumption of materials of any organisation would indicate that a handful to top high value items (less than 10 per cent of the total number) will account for a substantial portion of about 70 per cent of total consumption value .

Between these two extremes will fall those items the percentage number of which is more or less equal to their consumption value. Such an analysis of materials is known as ABC analysis or Proportional parts value analysis. Remember: 20% of total number of items account for only about 20% consumption value .• Remember: 70% of total number of items account for only about 10% of consumption value ."C"-group items. . Items in the top category are treated as "A" items."B" group items. items in the bottom category are called as "C" category items and the items that lie between the top and the bottom are called "B" category items.

Critical items i. lead time.. . high value items deserve very close attention and low value items need to be devoted minimum expense and effort in the task of controlling inventories.e. technical or other problems and its relative money value in the total investment in inventories. B and C categories • The logic behind this kind of analysis is that the management should study each item of stock in terms of its usage.• Classification of items into A.

. B and C items will not be worthwhile and would be very expensive. By controlling "A" items and doing a proper inventory analysis. ABC analysis also helps in reducing the clerical costs and results in better planning and improved inventory turnover. ABC analysis has to be resorted to because equal attention to A.• The Material Manager by concentrating on "A" class items is able to control inventories and show visible results in a short span of time. obsolete stocks are automatically pinpointed.

5. Accumulate value and add up number of items and calculate percentage on total inventory in value and in number. Mark off from the curve the rational limits of A. List out all the items and arrange them in the descending value. Draw a curve of percentage items and percentage value. 3. 1. B and C categories. Multiply the unit cost by the estimated annual usage to obtain the net value. B and C categories. (Annual Value) 4. 2. 6. Find out the unit cost and and the usage of each material over a given period. .ABC categorization: Steps • The following steps will explain to you the classification of items into A.


Application of Weighed Purchasing condition Uniform condition Items Conditions Weighed condition Items Conditions Re-order point=1 week supply A-class items 200 Delivery frequency=weekly Re-order point=2 week supply Delivery frequency=bi-weekly Re-order point=3 week supply Delivery frequency=every 4 weeks All items 4000 Re-order point=2 week supply Delivery frequency=weekly B-class items 400 C-class items 3400 .

5 weeks 800 1. B 400 15% 1600 2. delivery frequency is one quarter.5 weeks Total 4000 100% 16000 2.5 weeks 3400 3.925 weeks frequency reduced by 69%. require tighter control with more man・ hours. delivery 1.5 week supply. increased safety stock from 2. delivery frequency reduced to half.5 to 1. increased safety stock level by 20%. Less man・ hour required.Comparison of "Equal" and "Weighed" Purchase (4 weeks span) Equal purchase No of % of total ABC class No of delivery average supply items value in 4 weeks level Weighed purchase No of delivery average in 4 weeks supply level note A 200 75% 800 2. Drastically reduced man・hour requirement.5 weeks 800 2.5 weeks 5000 average inventory value reduced by 23%.5 to 3. Overall reduction of man・ hour requirement .5 weeksa same delivery frequency.5 weeks C 3400 10% 13600 2. safety stock reduced from 2.5 weeksa.

deterioration in quality. large space requirement etc.Stock Levels  Maintenance of proper stock of each item of materials is one of the main functions of stores department. Large quantity of material in store lead to huge investments. it is important to maintain stock level. One of the best way to maintain stock is to determine the minimum and maximum stock levels as per the necessity and maintain it regularly.  . Less stock also leads to higher costs. frequent purchases and loss of production etc. Therefore.

Store keepers usually use scientific technique of material management to ensure optimum quantity of material in store and make purchases accordingly. In order to do that following levels are fixed in advance: • • • • Maximum Stock Level Minimum Stock level Re-ordering level Danger level .

This level is called re-ordering level or ordering level. This level will usually be higher than the minimum stock level to cover unexpected delay in delivery of fresh supplies or abnormal usage of materials.• Reordering Level Re-ordering level is a level at which the storekeeper will initiate the steps to purchase fresh supplies. This level usually lies between minimum and maximum stock level. .

This is a level of an item of material below which the stock in hand is not allowed to fall.Lead time  Rate of consumption of material during the lead time.  Reorder level . The following points needs to be taken into consideration while fixing the minimum stock level.• Minimum Stock Level  Minimum stock level is a level of stock which must be kept in store at all times. The objective of this limit is to avoid the possibility of interruption of production due to shortage of material.  Time required for the fresh supply of material .

Time necessary for fresh delivery of materials. Price fluctuation. To avoid blocking of working capital and making undue investments in stock. Insurance costs if any • • • • • • • • • • . Following points must be taken into consideration while fixing maximum stock level: Availability of storage space Cost of carrying the inventory Amount of working capital available Economic ordering quantity Possibility of change in market trend Normal rate of consumption of material during the reordering process.Maximum stock level Maximum stock level is a quantity of material above which the stock of any item should not be allowed. maximum stock level is to be fixed. It also helps to maintain proper quality of raw materials. Possibility of loss due to deterioration/evaporation etc.

This is a level at which urgent action must be taken to procure new stock otherwise the stock may exhaust and could affect the production. . This level is calculated by taking into account the time required to get the materials by the shortest possible means.• Danger Level Danger level is a level below the minimum level.

Materials as a profit center .

since Purchasing Department was spending money on materials while Stores was holding huge inventory of materials. . • However. resulting in manufacturing organizations exposed to intense competition in the market place. • Progressive Management have since recognized that Materials Management can provide opportunities to reduce manufacturing costs and can be treated as a Profit Centre.• In the earlier years. Materials Management was treated as a Cost Centre. with the process of liberalization and opening up of global economy. • Indian manufacturers have been working out various strategies to face the above challenges and to cut down manufacturing costs to remain competitive. there has been a drastic change in the business environment. blocking money and space.

Suppose a firm is spending 50% of its volume on materials and the profits are 10% of sales volume. . a 10% increase in sales volume will be necessary. In other words. half the Sales income is spent on Materials. A 2% reduction in materials cost will boost the profits to 11% of sales or the profits will be increased by 10%. • To achieve the same increase in profit through sales efforts. • Organizations earn or loose large sums depending on how effective is their Materials Management.• On an average. compared to sales volume. material cost has five times the average on profits.

Using modern techniques like cost-price analysis to determine the right or reasonable price for the materials b) By managing taxes payable c) By reducing the cost of packaging d) By optimizing the transportation costs e) By ensuring the right quality of materials g) By import substitution .• The cost savings which are possible in Purchasing are as follows: a) By obtaining materials at lower prices through: •Development of new sources •Price negotiations with vendors .

the Selling Price is determined by the market forces and as such. Profit can be ensured only by reducing the Manufacturing Cost. In most of the organizations. .Manufacturing Cost = Profit In the current situation.Profitability Till the last decade. the equation in business could be stated as Selling Price = Manufacturing Cost + Profit In view of the current competitive pressures in the market. the equation has changed to: Selling Price . materials cost contribute to 60% of manufacturing cost and as such there is a significant importance to Materials Management.

by controlling the issue from the Stores.5 18.0 10. based on the norms for Production.0 10.0 70.0 17.5 17. Now let us see how Materials Management can improve the PROFITABILITY of an organization – Sales Materials Inventory Interest @ 15% Other expenses 100. including the Consumption? Yes. However.0 Manf.0 It may be seen from the above table.0 63.0 3.5 % Increase 85. . that just by reducing the material cost by 10%. the question is.0 100.Materials Cost is divided into two segments: a) Unit price of the Materials b) Consumption for Production The Purchase Department can control the prices by effective Negotiations. whether Materials Management can control the total cost.0 1.0 81. Costs PBT % on Sales 90. the Profit has increased by 85%.5 18. it is possible.0 20.0 10.

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