ABC Analysis in

Inventory Management

Facilitator - Pukhraj Verma

Pukhraj Verma 06/28/2025

 ABC Analysis

 ABC analysis is an inventory management

technique that determines the value of inventory
items based on their importance to the business.
 ABC ranks items on demand, cost and risk data,
and inventory mangers group items into classes
based on those criteria.
 This helps business leaders understand which
products or services are most critical to the
financial success of their organization
Pukhraj Verma 06/28/2025
 How ABC Analysis
Relates to the Pareto
Principle
 The Pareto Principle says that most results come
from only 20% of efforts or causes in any system.
 Based on Pareto’s 80/20 rule, ABC analysis
identifies the 20% of goods that deliver about
80% of the value.
 Most businesses have a small number of “A”
items, a slightly larger group of B products and a
big group of C goods, a category that that
defines the majority of items.
Pukhraj Verma 06/28/2025
 Classes in ABC Inventory
Management

Annual
Importan Percentage of Consumption
Type ce Total Inventory Value

Class A High 10% – 20% 70% – 80%

Rupee
value

Class B Medium 30% 15% – 20%

Rupee
value

Class C
Pukhraj Verma
Low 50% 5% 06/28/2025
Rupee
 How Is ABC Inventory
Analysis Calculated?

 Conduct ABC inventory analysis by multiplying the

annual sales of a certain item by its cost.
 The results tell you which goods are high priority
and which yield a low profit, so you know where to
focus human and capital resources.
 Use this formula for ABC inventory analysis:
(Annual number of items sold) x (Cost per item) =
Annual usage value per product

Pukhraj Verma 06/28/2025

 How Is ABC Inventory Analysis
Calculated? contd

 List each product or resource in descending order

according to its product usage value.
 Calculate the total of each item in the aggregate
amount.
 Determine the values for the A, B and C
categories, then assign a group name to each
item.

Pukhraj Verma 06/28/2025

 ABC Analysis Benefits

A long list of benefits can result from applying ABC analysis to

inventory management:

1. Increased Inventory Optimization: The analysis

identifies the products that are in demand. A company can then

use its precious warehouse space to adequately stock those

goods and maintain lower stock levels for Class B or C items.

Pukhraj Verma 06/28/2025

 ABC Analysis Benefits –contd…

2. Improved Inventory Forecasting: Monitoring and collecting data

about products that have high customer demand can increase the

accuracy of sales forecasting. Managers can use this information to set

inventory levels and prices to increase overall revenue for the company.

3. Better Pricing: A surge in sales for a specific item implies demand

is increasing and a price increase may be reasonable, which improves

profitability.

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 ABC Analysis Benefits –contd…

4. Informed Supplier Negotiations: Since companies earn

70% to 80% of their revenue on Class A items, it makes sense
to negotiate better terms with suppliers for those items. If the
supplier will not agree to lower costs, try negotiating post-
purchase services, down payment reductions, free shipping or
other cost savings.

5. Strategic Resource Allocation: ABC analysis is a way to

continuously evaluate resource allocation to ensure that Class
A items align with customer demand. When demand lowers,
reclassify the item to make better use of personnel, time and
Pukhraj space
Verma for the new Class A products. 06/28/2025
 ABC Analysis Benefits –contd…

6 Better Customer Service: Service levels depend on

many factors, like quantity sold, item cost and profit
margins. Once you determine the most profitable
items, offer higher service levels for those items.

7 Better Product Life Cycle Management: Insights

into where a product is in its life cycle (launch, growth,
maturity or decline) are critical for forecasting
demand and stocking inventory levels appropriately.

Pukhraj Verma 06/28/2025

 ABC Analysis Benefits –contd…

8. Control Over High-Cost Items: Class A inventory is

closely tied to a company’s success. Prioritize monitoring

demand and maintaining healthy stock levels, so there’s

always enough of the key products on hand.

9. Sensible Stock Turnover Rate: Maintain the stock

turnover rate at appropriate levels through methodical

inventory control and data capture.

Pukhraj Verma 06/28/2025
 ABC Analysis Benefits –contd…

10 Reduced Storage Expenses: By carrying the

correct proportion of stock based on A, B or C classes,
you can reduce the inventory carrying costs that
come with holding excess inventory.

11 Simplified Supply Chain Management: Use an

ABC analysis of inventory data to determine if it’s
time to consolidate suppliers or shift to a single
source to reduce carrying costs and simplify
operations.
Pukhraj Verma 06/28/2025
 The disadvantages of
ABC analysis

1 Parameter Instability:
ABC analysis often results in managers assigning
up to 50% of items to a new category every
quarter or year. Often, companies are not aware
of the changes until there is a problem with
demand, and the need to reassess may take up
valuable time and jeopardize customer
satisfaction.

Pukhraj Verma 06/28/2025

 The disadvantages of ABC analysis
-contd

2. Limited Pattern Consideration: The standard ABC

method will not account for factors like new product
introductions or product seasonality. For example, a new
product may have low sales volume because it has no
buying history. ABC analysis has a somewhat static
perspective on demand and will generate inventory
inefficiencies whenever demand is shifting or unclear.

3 Low Information Extraction: ABC class

information may not provide all the statistical data or
detail needed to make informed, strategic management
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decisions.
 The disadvantages of ABC analysis
-contd

4 High Resource Consumption:

Giving disproportionate weight to trivial issues is
known as bike shedding, which can be an unfortunate
consequence of ABC analysis. Since ABC analysis is
easy to grasp, staff may inject their opinions or
request their own variants making ABC analysis a
resource-consuming process rather than a time-
saving tool.

Pukhraj Verma 06/28/2025

 The disadvantages of ABC analysis
-contd

5. Value Blindness:
ABC analysis ascribes product importance based on
revenue or frequency of use, but some items may not
hold to this paradigm. For example, a retail display item
may rarely sell but may attract a lot of customers (who
will buy other products) based on its novelty. In
aerospace, a specific part for a plane may not be used
often and have little market value, but it may be a
fundamental safety function.

Pukhraj Verma 06/28/2025

 The disadvantages of ABC analysis
-contd

6. System Incompatibility:
ABC inventory analysis conflicts with traditional
costing systems and is out of compliance with
generally accepted accounting principles (GAAP)
requirements. If you must run multiple costing
systems, labor costs will rise alongside inefficiency.

Pukhraj Verma 06/28/2025

 The disadvantages of ABC analysis
- contd

7. Undersupply or Oversupply Issues:

One ABC analysis disadvantage is it looks at dollar-
based values, rather than the volume that cycles
through inventory, so there is a risk of running out
of Class B or C items. The opposite can occur, too.
You may have excess low-class items that
accumulate in inventory if you reorder them
without regular reviews.

Pukhraj Verma 06/28/2025

 The disadvantages of ABC analysis
-contd

8. Loss Risk: Just because B and C items do not have as

high value as Class A products does not mean they have no
value. One of the limitations of ABC analysis is that excess
stocks are always in jeopardy of obsolescence or damage.
Therefore, the inventory that habitually goes uncounted or
unmonitored may be subject to theft.

9. Mandatory Standardization: The ABC method is only

successful if every item is subject to the standardization of
materials, which includes how they are named, stored, and
consistently rated and monitored.
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 The disadvantages of ABC
analysis-contd

10. Arbitrary Categorization:

Without preset boundaries or agreed-upon standards for
each category, classifying goods depends on the
manager's professional judgment. So this can be a
relatively subjective process.

11. Business Limitations:

ABC analysis is not useful for companies that have an
equable annual consumption value of inventory items by
type. For instance, a company that sells the same
version of an item like candy, nails or socks, may not be
able to sort stock based on the Pareto Principle.
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 The disadvantages of ABC analysis
-contd

12. High Resource Consumption:

Companies with a significant number of inventory items
will have to hire additional staff or buy special
equipment to control inventory using ABC
categorization

Pukhraj Verma 06/28/2025

 HOW TO PERFORM AN
ABC ANALYSIS STEP-BY-
STEP
1. Identify the Objective: An ABC analysis can help
you meet one of two targets: lower procurement
costs or raise cash flow by optimizing inventory levels
of the right items based on customer sales or
production.

2. Collect Data: The most common data to collect is

the annual spend on each item. This data is in raw
purchase dollars. If it’s easy to calculate, you can
gather the weighted cost, including gross profit
margin, ordering and carrying cost data.
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 how to perform an ABC analysis
step-by-step-contd

3. Sort by Decreasing Order of Impact: Use the ABC

analysis formula to rank each inventory item’s order by
cost — from highest to lowest impact.
4. Calculate the Sales Impact: For each inventory item,
calculate its impact on sales as a percentage by dividing
the annual item cost by the aggregated total of all items
spent. This number is the percent, or fraction, that you
will use to compare items in the list.
Here’s the formula:
% Impact = (annual item cost) / (aggregated total of
all items spent) x 100
Pukhraj Verma 06/28/2025
 how to perform an ABC analysis
step-by-step-contd

5. Sort Items into Buy Classes: Once you define the

classes, work on contract renegotiation, vendor
consolidation, shifting strategic sourcing methodology or
implementing e-procurement. Making changes in these
areas can provide significant savings or ensure the in-
stock availability of Class A items. Take a holistic view
rather than being strict about the 80/20 rule.
6. Analyze Classes: Once categories and strategic
cost management are defined, schedule reviews to
monitor the success or failure of decisions.

Pukhraj Verma 06/28/2025

 Economic Order Quantity
(EOQ)

The economic order quantity (EOQ) is

the order quantity that helps minimize
holding costs and order costs for a
business.

Pukhraj Verma 06/28/2025

 What is Economic Order
Quantity?

 Economic order quantity (EOQ), refers to the

optimum amount of an item that should be
ordered at any given point in time, such that the
total annual cost of carrying and ordering that
item is minimized.
 EOQ is also sometimes known as the optimum lot
size. Simply put – how much product should you
purchase to maintain a cost-efficient supply
chain?

Pukhraj Verma 06/28/2025

 Why is the EOQ important?

 The EOQ helps companies minimize the cost of

ordering and holding inventory.
 As per the economic concept known as
economies of scale, the cost per unit of ordering
a product falls, the larger the total quantity of the
order. However, the larger the total quantity of
an order, the higher the cost to hold and carry
your inventory.

Pukhraj Verma 06/28/2025

 EOQ formula

1. Determine the demand in units

2. Determine the order cost (incremental cost to
process and order)
3. Determine the holding cost (incremental cost to
hold one unit in inventory)
4. Multiply the demand by 2, then multiply the result
by the order cost.
5. Divide the result by the holding cost.
6. Calculate the square root of the result to obtain
EOQ.

EOQ = square root of (2 x D x S/H) or √ (2DS / H)

Pukhraj Verma 06/28/2025
 EOQ formula -contd

EOQ = square root of (2 x D x S/H) or

√ (2DS / H)
Where:
 D represents demand, or how many units of
product you need to buy.
 S represents setup cost.
 H represents the holding fee or storage cost per
unit of product

Pukhraj Verma 06/28/2025

 Use of EOQ in Inventory
control

 The EOQ is usually used to set the reorder point

within your inventory management workflows.
 It will tell you when to place an order (reorder
point) and how much order to place (EOQ formula).
 This prevents you from carrying too much
deadstock or facing stocko uts

Pukhraj Verma 06/28/2025

 Assumptions in EOQ

The assumptions on which the EOQ is based are as

follows:
1. Demand is relatively constant and is known.
2. The item is produced or purchased in lots or
batches and not continuously.
3. Order preparation costs and inventory-carrying
costs are constant and known.
4. Replacement occurs all at once.

Pukhraj Verma 06/28/2025

 THANK YOU

Pukhraj Verma 06/28/2025