ABC ANALYSIS

ABC Analysis, short for Always Better Control Analysis, is an inventory management technique used
to categorize inventory items based on their value and significance to the business.

The primary goal of ABC Analysis is to prioritize inventory management efforts by focusing
more on the most valuable items (Category A), while allocating less attention to lower-value
items (Categories B and C). This method helps businesses optimize their inventory control
processes, reduce costs, and ensure that critical items are always in stock.

• ABC analysis is based on Pareto principle (80-20 rule) which states that 80% of the overall
consumption value (expense) is based only on 20% of the total items. i.e. small portion of the
items may typically represent the bulk of money value, while a relatively large number of
items may form a small part of the money value.

• ABC analysis is a method for dividing on-hand inventory into three classifications A, B, C
based on annual consumption unit .

• “A” items : money value is highest 70%, represent only 10% of items

• “B” items : money value is medium 20%, represent about 20% of items

• “C” items : money value is lowest 10%, represent about 70% of items.

One strategy you can use in a perpetual system is ABC analysis. This classifies inventory
items based on the item’s consumption value. That value is the total value of a piece of
inventory consumed over a specific time frame. The letters stand for the different categories
items can be placed into.
ABC analysis in inventory control classifies stocks based on their importance, price, and
sales volume. These criteria determine the number of items a company will bring to the
market.

Just as its name suggests, it consists of the following categories:

 A class – expensive, high-class items with tight controls and small inventories
 B class – average-priced, mid-priority items with medium sales volume and stocks
 C class – low-value, low-cost items with high sales and huge inventories

Applying the ABC analysis of inventory control allows businesses to minimize the costs of
carrying products while maximizing their stock returns.

 A items refer to goods with the highest consumption values. This will be a low
number of items with a high consumption value.
 B items are the category with less consumption value than A but higher than C
items.
 C items have the lowest consumption value. The risk on this stock is low, but so are
the returns. They often make up a good portion of your stock.

The table below is an example of how this system would be implemented in practice:

Advantages of ABC analysis :

1. Helps to exercise selective control over such items, which are having a sizable investment.
2. Helps to point out obsolete stocks easily.
3. Provides sound basis for allocation of funds & human resources.
4. It enables the maintenance of high inventory turn over rate.

Disadvantages of ABC analysis :

1. Considers only money value of items & neglects the importance of items for the
production process or assembly or functioning.
2. It does not categorize the items based on their critical needs, hence sometimes the purpose
of ABC categorization may be defeated.

VED Analysis:

VED Analysis attempts to classify the items used into three broad categories, namely Vital,
Essential, and Desirable. The investigation characterizes things on the premise of their
criticality for the business or organization.
 Vital(V): Vital category things are those things without which the generation exercises or
some other action of the organization, would stop, or possibly be definitely influenced.

The medicines that are critically needed for the survival of the patients, which must be
available in the hospital all the times. Vital items (V) are items like Oxygen which are vital
for functioning of a health care establishment and whose shortage will have serious adverse
effects on routine functioning of the organisation.

Essential(E): Essential items are those items whose stock– out cost is very high for the
company. Essential items which reduce the equipment’s performance but do not render it
inoperative or unsafe; non-availability ofthese things may bring about transitory loss of
creation or separation of generation work; substitution can be postponed without influencing
the gear's execution truly; brief repairs are at times conceivable.

Medicines with lower critical need, which may be available in the hospital. Essential items
(E) are the items whose shortage or non– availability can only be afforded for a short time
(such as intravenous sets & IV fluids in a hospital) and if their shortage continues for
anything more than the shortest time, the functioning would be affected seriously and
adversely.

Desirable(D): Desirable things are those things whose stock-out or need causes only a minor
intrusion for a short length in the Production plan. The cost brought about is exceptionally
low.

The remaining medicines with lowest critically, the absence of which will not be detrimental
to the health of the patients. These are items whose shortage would not affect the routine
functioning of an organisation even if the shortage is for a long time (such as Vit E capsules
or sun screen lotions in a hospital’s medical store).

For V items, a large stock of inventory is generally maintained, while for D items, minimum
stock is enough • However if we only consider VED analysis alone, ideal control can be
exercised on the vital or essential category.

VEDAnalysis is very useful to categorize items of spare parts and components. In fact, in the
inventory control of spare parts and components it is advisable, for the organization to use a
combination of ABC and VED Analysis. Such control system would be found to be more
effective and meaningful.

ECONOMIC ORDER QUANTITY(EOQ):

The economic order quantity (EOQ) refers to the ideal order quantity a company should
purchase in order to minimize its inventory costs, such as holding costs, shortage costs, and
order costs. Economic order quantity is necessarily used in inventory management, which is
the oversight of the ordering, storing, and use of a company's inventory. Inventory
management is tasked with calculating the number of units a company should add to its
inventory with each batch order to reduce the total costs of its inventory.
Economic Order Quantity (EOQ) is a model used in inventory management to
determine the optimal order quantity that a company should purchase to minimize
the total cost of inventory. This model takes into account the cost of ordering and
holding inventory, as well as the cost of stockouts.

In order to understand the EOQ model, it is important to first understand the two
main costs associated with inventory: holding costs and ordering costs. Holding
costs are the costs associated with storing and maintaining inventory, such as
warehouse space, insurance, and depreciation. Ordering costs are the costs
associated with placing an order for inventory, such as the cost of processing the
order, transportation costs, and any discounts or bulk purchasing costs.

The EOQ model uses these two costs to determine the optimal order quantity that
minimizes the total cost of inventory. The formula for EOQ is as follows:

EOQ = √(2DS/H)
Where:
D = Annual demand for the item
S = Cost of placing an order (Setup costs (per order, generally including
shipping and handling))
H = Holding cost of one unit per year

The EOQ formula assumes that the demand for the item is constant and that the lead
time for the item is negligible. The model also assumes that the ordering and
holding costs are constant, and that there is no stockout cost.
Who it is important for?
The Economic Order Quantity (EOQ) model is important for any company or
organization that manages inventory. This includes businesses in a variety of
industries such as retail, manufacturing, healthcare, and logistics.

In retail, the EOQ model can help companies to minimize the total cost of
inventory and improve customer service by ensuring that they always have enough
inventory on hand to meet customer demand.

In manufacturing, the EOQ model can help companies to minimize the costs
associated with ordering and holding raw materials, and improve efficiency by
ensuring that they always have the necessary materials on hand to meet production
needs.

In healthcare, the EOQ model can be used to manage the inventory of medical
supplies, helping hospitals and clinics to minimize costs and ensure that they always
have enough supplies on hand to meet patient needs.

In logistics, the EOQ model can be used to manage the inventory of shipping and
packaging materials, helping companies to minimize costs and ensure that they
always have enough materials on hand to meet shipping needs.
Overall, the EOQ model is important for any company or organization that needs to
manage inventory in an efficient and cost-effective manner. It can help companies
to minimize costs, improve efficiency, and ensure that they always have enough
inventory on hand to meet customer demand.

Advantages of using EOQ model in inventory management

There are several advantages to using the Economic Order Quantity (EOQ) model in
inventory management. These include:

 Minimizes total inventory costs: The EOQ model helps companies to minimize
the total cost of inventory by determining the optimal order quantity. By using
the EOQ model, companies can reduce the costs associated with ordering and
holding inventory.
 Improves customer service: By determining the optimal order quantity,
companies can ensure that they always have enough inventory on hand to meet
customer demand. This can lead to higher customer satisfaction and increased
sales.
 Easy to use: The EOQ model is a simple and easy-to-use tool for inventory
management. The formula for EOQ is straightforward and can be easily
implemented in practice.
 Can be used in conjunction with other inventory management
techniques: The EOQ model can be used in conjunction with other inventory
management techniques, such as safety stock, reorder points, and just-in-time
inventory systems to provide a comprehensive inventory management strategy.
 Helps to improve forecasting: By determining the optimal order quantity,
companies can improve their forecasting abilities by having a better
understanding of their inventory needs.
 Helps in setting inventory levels: EOQ model helps in determining the right
inventory level that is neither too high nor too low, thus, reducing the carrying
cost and also the ordering cost.
 Helps in determining the reorder point: EOQ model also helps in determining
the reorder point, the point at which an organization needs to place an order for
new stock.

In conclusion, the EOQ model is a useful tool for inventory management that can
help companies to minimize the total cost of inventory, improve customer service,
and assist in forecasting and setting inventory levels. It is easy to use, and can be
used in conjunction with other inventory management techniques. However, it’s
important to keep in mind that the EOQ model has some limitations and should be
used in conjunction with other inventory management techniques to provide a
comprehensive inventory management strategy.

Disadvantages of using EOQ model in inventory management

There are a few disadvantages to using the Economic Order Quantity (EOQ) model
in inventory management. These include:

 Assumes constant demand: The EOQ model assumes that the demand for the
item is constant, which may not always be the case in the real world. If demand
 is not constant, the EOQ model may not accurately reflect the optimal order
quantity.
 Neglects lead time: The EOQ model assumes that the lead time for the item is
negligible, which may not be the case for all items. This can lead to inaccuracies
in the EOQ calculation if lead time is not considered.
 Constant costs: The model assumes that the ordering and holding costs are
constant, which may not be the case for all companies. If these costs vary, the
EOQ model may not accurately reflect the optimal order quantity.
 No stockout cost: The model does not consider the cost of stockouts. In real
world scenarios the cost of stockouts can be significant and should be taken into
account when determining the optimal order quantity.
 Only one item: EOQ model is applicable when the inventory system is dealing
with only one item. If the inventory system is dealing with multiple items, this
model is not applicable.
 Simplistic: EOQ model is relatively simplistic, it does not take into account all
the possible complexities that a real-world inventory system may have, such as
demand uncertainty, multiple products, multiple suppliers, and stochastic lead
times.
It’s important to keep in mind that the EOQ model is just one tool that can be used
in inventory management. In practice, companies may use a combination of
different inventory management techniques and consider other factors such as lead
time, demand variability, and supplier reliability when determining their inventory
strategy.