ABC Analysis

ABC analysis is an inventory classification method that ranks every stock item by its annual consumption value and splits the ranked list into three classes, so that stock counting, reorder settings and purchasing attention go to the lines that carry the value rather than being spread evenly across the catalog. Class A holds the small number of items that account for most of the value, class C the long tail that accounts for very little, and class B what sits between them.

The arithmetic

Two calculations are involved. The first values each item over a year:

Annual consumption value = annual demand (units) x unit cost (£)

Sort every item by that figure, highest first. The second calculation runs down the sorted list:

Cumulative percentage = (running total of annual consumption value / total annual consumption value) x 100

Classes are then cut at cumulative percentage thresholds, conventionally 80% and 95%. The item that crosses a threshold goes into the higher class, so the bands are read as 'up to and including the line that passes 80%'.

A worked example

Eight stock lines, one year of demand, total annual consumption value £100,000. Annual consumption value is annual demand multiplied by unit cost.

1. A-101: 12,000 units x £5.00 = £60,000. Cumulative £60,000, which is 60.0%. Class A.
2. A-102: 3,000 units x £8.00 = £24,000. Cumulative £84,000, which is 84.0%. This line crosses the 80% threshold, so it is the last class A item.
3. B-201: 2,000 units x £4.00 = £8,000. Cumulative £92,000, which is 92.0%. Class B.
4. B-202: 800 units x £5.00 = £4,000. Cumulative £96,000, which is 96.0%. This line crosses 95%, so it is the last class B item.
5. C-301: 1,500 units x £1.00 = £1,500. Cumulative £97,500, which is 97.5%. Class C.
6. C-302: 500 units x £2.00 = £1,000. Cumulative £98,500, which is 98.5%. Class C.
7. C-303: 400 units x £2.50 = £1,000. Cumulative £99,500, which is 99.5%. Class C.
8. C-304: 250 units x £2.00 = £500. Cumulative £100,000, which is 100.0%. Class C.

The result: 2 of 8 lines, 25% of the range, are class A and carry £84,000 or 84% of the value. Two more lines are class B, carrying £12,000 or 12%. The remaining four lines, half the range, are class C and carry £4,000, which is 4% of the annual value. Adding the three classes back gives £84,000 plus £12,000 plus £4,000, which is the £100,000 total.

Eight lines is small enough to check by hand, and checking one small set by hand before trusting a larger calculation is worth the ten minutes. The proportions above are what a concentrated range looks like; a business with flat demand across a broad catalog will find its class A band wider, and the thresholds are a starting convention rather than a rule.

What to do with the classes

Classification only pays for itself once it changes a policy. Class A items justify frequent counting, tight reorder points reviewed against current lead times, and a human decision on each purchase. Class B items suit periodic counts and standing reorder rules with a quarterly review. Class C items suit simple minimum and maximum levels, infrequent counting, and are the first candidates for range rationalization, since they occupy storage and working capital in return for very little turnover.

The class also sets what the surrounding calculations are worth doing. Reworking economic order quantity for a class C item saves less than the time it takes; doing it for class A is where the saving lives, and the same goes for measuring stock turnover line by line. Zigaflow's inventory holds the reorder point, purchase history and stock level per SKU that the calculation runs on.