ABC System of Inventory Control
Inventories include raw material inventory, work-in process inventory and finished
goods inventory. The goal of effective inventory management is to minimize the total
costs – direct and indirect – that are associated with holding inventories. However, the
importance of inventory management to the company depends upon the extent of
investment in inventory. It is industry-specific.
In the case of a manufacturing company of reasonable size the number of items of
inventory runs into hundreds, if not more. From the point of view of monitoring
information for inventory control, it becomes extremely difficult to consider each one
of these items. The ABC analysis comes in quite handy and enables the management
to concentrate attention and keep a close watch on a relatively less number of items
which account for a high percentage of the value of annual usage of all items of
inventory.
A firm using the ABC system segregates its inventory into three groups – A, B and C.
The A items are those in which it has the largest dollar investment. A group consists
about 10 percent of the inventory items that account approximately for 70 percent of
the firm’s dollar investment. These are the most costly or the slowest turning items of
inventory. The B group consists of the items accounting for the next largest
investment. This group consists approximately 20 percent of the items accounting for
about 20 percent of the firm’s dollar investment. The C group typically consists of a
large number of items accounting for a small dollar investment. C group consists of
approximately 70 percent of all the items of inventory but accounts for only about 10
percent of the firm’s dollar investment. Items such as screws, nails, and washers
would be in this group.
Dividing its inventory into A, B, and C items allows the firm to determine the level
and types of inventory control procedures needed. Control of the A items should be
most intensive due to the high dollar investments involved, while the B and C items
would be subject to correspondingly less sophisticated control procedures.
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