ABC Analysis of Inventory: Optimize Business Bottom Line

The most common concern supply chain management experts struggle with is accurately identifying the causes of inventory inconsistencies. If a discrepancy is identified when users pick an item or perform a count, an inventory correction needs to be performed.

Every inventory issue has a specific method that can be adopted to resolve it. Start by determining the most likely or easiest-to-identify possibilities and either proving them or eliminating them from the list of root causes. This part of the process first requires confirming the calculations. Perform a recount of the inventory in question, preferably by someone who was not involved in the initial count.

Categorizing your inventory

There are several cycle counting approaches available in OptiProERP, but the ABC classification method is most common. ABC analysis strategy is used to classify data into three categories based on the values of the target measured in descending order.

This strategy is used to classify products based on a particular measure (such as value or lead time). It is based on an assumption that inventories of an organization are not of equal value, and can be grouped into three categories (A, B, and C) by their estimated value/importance. “A” items are very important for an organization, “B” items are of medium importance and “C” items are of the least importance.

An example of ABC classification is as follows:

• “A” items – About 20% of the items amount to approximately 70% of the value.
• “B” items – About 30% of the items amount to approximately 20% of the value.
• “C” items – About 50% of the items amount to approximately 10% of the value.

“A” items are also generally those with a long purchase lead time, “B” items have an average lead time, “C” items are readily available.

You are not restricted to just three groups. You can have more, but too many will complicate your analysis and cycle counting routines.

System tools to help

OptiProERP’s manufacturing ERP has a number of dashboards and tools to perform the analysis of your inventory to define the appropriate ABC classifications for you.

How often do you need to count?

Once the items are classified as “A”, “B” and “C”, the cycle counts need to be established for these groups of items. In OptiProERP, an effective cycle counting program deploying the ABC method contains two critical drivers:

1. Cycle Codes – separates the inventory cycle into groups based on such criteria as date, time, and recurrence.
2. Cycle Recurrence – is established for each inventory cycle, which could be weekly, monthly, annually or none. This determines when and how frequently the items are counted.

Now, take a step back from the most basic guidelines, and consider the following questions:

• Does ABC analysis hold up at your company? How many low-dollar, high-volume items such as screws, nuts, bolts, and washers do you have? 
• What type of manufacturing industry do you represent? Is your company a job shop, a custom builder, or something else? At what pace are you producing? Do you deal with high or low volumes? Push systems or pull systems?

Finding discrepancies

Before you can fully understand your inventory and initiate measures to optimize your business, you may have to do some digging. Only then can you implement the right cycle counting program to maximize your company’s bottom line. 

What do you do when your ERP system indicates that you have less on-hand than your physical count?

• If the inventory item can be sold as a finished good or serviced part; examine whether you shipped a customer the correct part, but the wrong part was on the sales order.
• If the inventory item is purchased; investigate whether the parts were put in inventory, but the receipt has not been posted.
• If the item is a component or subassembly; search recent pick lists that contain the item, or do a where-used inquiry on your active bills of material (BOMs).

Essentially, you are looking for a transaction in your ERP system that doesn’t belong. This is one of the easier problems to identify. A more challenging issue is identifying a transaction that was never created earlier. This is when you have more inventory in your ERP system than you physically have on-hand. There should have been a transaction, but there wasn’t.

Here are some options available to you if you have more inventory in your ERP system than you physically have on-hand:

• If the inventory item can be sold (finished goods or service parts); ask whether you shipped a customer the wrong part, but the correct part was on the pick list? Is there another item where the physical stock is less than the computer inventory shows?
• If the inventory item is purchased; take a look at the parts that were received in your ERP system. Have they not yet been put in inventory?
• If the inventory item is a component or subassembly; examine whether you have the wrong part on a BOM?

A good place to start looking where errors potentially could have occurred is in the inventory report. Here you can drill down to the transactions for any item. The other fields are filled with data once you expand any item in the grid.

Using ABC to analyze your inventory

After having performed the cycle count and sorting out the inventory inconsistencies, let us get to the ABC analysis. ABC analysis is not a process to maintain accuracy; it is designed to discover methods to optimize the inventory. And the best possible method to identify these inventory levels is to slice and dice the inventory data by analyzing it in different charts and views. With OptiProERP, you get to present the ABC analysis data in various chart types. This makes the analysis all the more meaningful and accurate.

You can drill down into any or all groups to obtain a clear picture of what is happening with each.

We believe, your ERP system simulates your manufacturing environment. The more accurate information you give it, the better the simulation. When the simulation is out of sync with reality, inconsistencies occur. The further you are in distance and time between something happening and recording it, the more opportunity for error you have.

Conclusion

Finally, whatever the cause of an inventory discrepancy, make sure to close the loop by notifying the appropriate person so the problem is corrected. Once an organization has been made aware of the issue, keep monitoring the inventory to ensure that the corrective action is effective. Over time, this will have a powerful impact on the bottom-line of your business.

Streamlined accounting and warehouse management software offer better insights from connected systems and reporting that is easy to create and analyze.

Connect with us to explore how OptiProERP can improve your business today and help you achieve your ambitions for tomorrow, contact us now!