ABC Analysis of Inventory Control | Cost Accountancy

In this article we will discuss about the BC Analysis of Inventory Control:- 1. Meaning of ABC Analysis 2. Advantages of the ABC Analysis 3. Limitations.

Meaning of ABC Analysis:

In case of a big manufacturing unit which uses a large number of items for production purpose, it becomes difficult to comprehend such enormous number of items, the unit has to keep in stock. Sometime a modern industrial unit has to keep 30,000 to 50,000 units.

So, many manufacturing units find it useful to divide materials, parts, supplies and finished goods into sub-classifications for purposes of effective stock control.

ABC method is a technique under which items of stocks are sub-classified in “step-by-step” fashion by:

(i) Itemizing total annual purchase cost of each time needed and

(ii) Grouping in decreasing order of annual consumptions cost.

Under this system different materials are grouped into three classes:

(i) High priced materials (A)

(ii) Medium priced materials (B)

(iii) Low priced materials (C)

Materials to be handled under each category are converted into a percentage of the total value of the material.

The following figure will demonstrate the technique of ABC analysis of material inventory:

ABC Analysis of Material inventory:

Step I and II

The above chart demonstrates that “A” items consist of only 5% of total items handled but they represent 70% of the total value of stock-holding of the business. The second category “B” consists of 25% of total items representing 20% of the total value of stock, while the third category “C” consisting of 70% of total items represent only 10% of total cost of inventory.

At the time of classifying the items the following factors should be considered:

(i) Value of consumption.

(ii) Investment value.

(iii) Sales or profit potential.

Advantages of the ABC Analysis:

(i) This method ensures availability of supplies at all times.

(ii) Clerical cost can be reduced and inventory is placed and maintained at the optimum level.

(iii) Close and strict control on costly items can be exercised.

(iv) Working capital management can be better planned.

(v) Frequency of placing order for different classes of items can reasonably be judged.

(vi) There exists the element of flexibility in material control management. Very strict control, moderate control and loose control can be exercised for A, B & C categories of items, respectively.

Limitations of ABC Analysis:

1. In order to be fully effective, ABC analysis should be carried out with standardi­sation and codification.

2. As ABC analysis is based on gradation of different items, this gradation may include a lot of subjective elements.

3. The result of ABC analysis should be reviewed periodically and updated.

Despite these limitations, ABC analysis is a powerful tool in the direction of cost reduction, as it helps to control inventory items with a selective approach. No. of Items

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