Inventory Analysis Can Save You Money!

Inventory Analysis Can Save You Money!

In retail, food service, and manufacturing, Inventory Control is imperative.  Minimum and maximum ordering levels will help assure you that you have the right quantities on hand.  Not too much and never running out is the goal. Running out of inventory is an obvious concern; got nothing to use to produce the product/service or sell, while excessive inventory is, simply put, money sitting on the shelf not making you money.

Velocity analysis will allow you to understand what SKUs or products are moving quickly and what items hardly move at all, for better planning and less stale inventory. But the analysis we want to talk about today is the A, B, and C item categories. Another usual method of inventory control is referred to as rate of movement analysis. The concept is the same but the faster some products or items that are in the A-category and even B-category may require more regular scrutiny for optimal movement levels. Have you ever heard of that? Read on…

The concept of A, B, and C items in inventory control is a way of categorizing inventory based on its value and usage frequency, which helps in prioritizing management efforts and resources for different items. This classification is commonly referred to as ABC analysis and is based on the Pareto Principle (80/20 rule), where a small percentage of items account for a large portion of value or consumption in inventory.

Here’s a breakdown of each category:

1. A Items: High-Value, Low-Quantity
   • Characteristics: These are the most valuable items in the inventory, often accounting for a significant portion of the total value (e.g., 70-80%) but a smaller portion of the total inventory quantity (e.g., 10-20%).
   • Management Focus: Due to their high cost and critical nature, these items require careful monitoring, accurate forecasting, and frequent review. They might also need stricter inventory controls, such as regular stock audits or tight reorder points.
   • Example: Expensive machinery parts or high-demand products that generate a lot of revenue.
2. B Items: Moderate-Value, Moderate-Quantity
   • Characteristics: B items fall between A and C items in terms of value and quantity. They typically represent around 20-30% of the total inventory value and quantity.
   • Management Focus: These items receive moderate attention, with regular reviews and reasonable controls. The frequency of review and restocking might be less than A items but still consistent.
   • Example: Mid-range products or parts that support business operations but are not as crucial as A items.
3. C Items: Low-Value, High-Quantity
   • Characteristics: C items make up the majority of the inventory quantity (e.g., 50-70%) but only a small fraction of the total inventory value (e.g., 5-10%).
   • Management Focus: Because these items are less valuable, they require minimal control and can be ordered in bulk or reviewed less frequently. C items often have a simpler reorder process to save time and resources.
   • Example: production supplies or inexpensive spare parts.

By categorizing inventory items this way, companies can apply different levels of control based on the item’s value and importance, allowing them to allocate resources more effectively and minimize the risk of stockouts or excessive inventory costs.

Therefore, very tight controls and Just-In-Time ordering on those key expensive items that go into our product become important for A items.  Good controls, but ordered in a little larger bulk for items that have a lower unit price and is used in larger quantities become our B items.  And inexpensive items that are used ubiquitously throughout the process, order in large quantities and often make freely available to the production staff are our C items. This assures not only savings from tight controls, but also from freeing up purchasing and receiving time for less valuable inventory.

Let’s say that you make wooden doors; wood might be your B items because you use so much of it and its price is high but reasonable.  Glass is expensive, often special ordered, and you use less of it than wood so that might be an A item.  And the screws and glue that you use in the manufacturing process would be C Items. Does this make sense? There are more examples in the restaurant and manufacturing trades which makes it more critical to categorize the items in this way.

So, a good purchasing plan might be to buy you wood in bulk especially when the price is right because you will always need wood.  Order glass sparingly or only when you have a demand for it.  And keep screws and glue always available and perhaps on an open purchase order.

Ideally you want to own your inventory, including raw, work in process, and finished goods for as short a time as possible.  Inventory sits on your balance sheet, and is considered an asset just like cash, even though you cannot spend it until you sell it.  Therefore, we often say that “inventory is evil”.  Perhaps a bit harsh sounding but you get the idea. It is, however, a necessary evil, so some simple analysis becomes critical to allow you to reduce your inventory investment while also meeting your customer demands.

Unless you have tons of money, and few business owners really do, and are willing to risk ending up with a warehouse of inventory that is useless or seldom used. Inventory Analysis and Control are imperative in managing your business and its cashflow.

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