ABC analysis is the classification technique based on the Pareto principle. It is used when determining which items in a company’s inventory should get priority (Ravinder and Misra, 2014). This method focuses on the working capital and carrying costs by checking on the value of stock held at a time and unnecessary or excess stock. Managers can, therefore, distinguish items to do away with and items to stock-up.
Application of ABC analysis
A car-dealer can apply ABC analysis in calculating the number of orders to make annually and the optimal number of units per order. Given a car-dealer selling automobiles, spare parts and automobile-services, the three products will be ranked into categories, A, B and C where Group A comprises of most valuable item and group C is least valuable. As such, automobiles will fall in A, spare parts in B and services in C. Since associated cost of automobiles is high, a few units will be ordered frequently to avoid stock-outs but minimize holding costs. Furthermore, automobile-services being aftermarket operations will be stocked in bulk and rarely re-ordered. Spare parts will be utilized as complementary products to either the purchase of an automobile or service upon enquiry. The number of automobile-parts per order will be slightly higher than that of automobiles as less holding cost is incurred for these parts.
Car-dealerships always use estimated sales to gauge the market and know when to alter prices. They also rank operations using activity-based costing such that operations that can be accomplished within the dealership are prioritized as opposed to those that need outsourcing. The use of ABC analysis gives reasons for such operating decisions and offer managers a transparent way to make priorities clear (Ravinder and Misra, 2014). Therefore, this analysis is important in keeping track of stock, operations and labour hence inventory is controlled and profit maximized.
Ravinder, H. & Misra, R. B. (2014) ABC Analysis for inventory management: Bridging the gap between research and classroom. American Journal of Business education- Third Quarter 2014. 7(3), 257-264. Retrieved from htpps://www.google.com/url?sa=t&source=wed&rct=j&https://files.eric.ed.gov/fulltext/EJ1053624.pdf