How to calculate ABC inventory?
Now for the deep dive.
Hold your nose and take a deep breath.
First, let’s look at an example inventory for a leather goods business anddetermine which items would be in which classification. To start, we got the columns beside each item which show the annual demand as well as the cost per unit. This is going to be the starting point for your calculations.
After that, you want to multiply the demand and cost to get the annual cost for each item. And then, you want to add up all of them so you can get a total cost for the whole inventory.
The table above shows you the value that each item brings and the total of all of them — $19,475.
Now, you can divide each annual cost of an item by the total annual cost of all items. This will give a percentage figure whichgives an idea of how valuable the items are individually.
And once that has been done, you can sort them from largest to smallest to get a clear overview.
With this information, we can see, right in front of us,which products have the most and least usage value.
This is where the magic happens.
Apply the general rule ofthumbforABCinventorymanagementas mentioned before:
- ItemA— The top 15% represent 70% of sales
- Item B — The middle 20% represents 20% of sales
- Item C — The bottom 65% represents 10% of sales
Starting with item A, we are looking for around the top 15% of products to bring 70% of sales. In this case, we can see that backpacks alone only bring around 50% of the total annual cost. But once youalsoadd belts into the mix, then we can see that we have just over 70% of sales.
There we have it, backpacks and belts are designated as item A.
Obviously,this doesn’t have to be precise,and the values in this exampleare quite crude, butyou will be surprised to find out how often this pattern works.
So anyway, nowwecan look to see what item Bsaregoing to be.
Adding up collars, flasks, and handbags takes us to just over 17%. We couldadd journals to get to 20% of sales but there isaclear distinction between theannual cost of journalsand phone cases.
It makessenseto draw the line there.
And everything below that line, as the weakest of our stock, is going to be classified as item C.
Here is the final picture for clarity:
You can do the exact same process yourself withasimple spreadsheet.
Just note that the purpose here is todistinguish items from each otherin termsof their usage value. Don’t worryabout the numbers matching up exactly.
Think about the purpose of this exercise in classifying your products effectively.
