ABC Analysis and Inventory Control Entrepreneurship Class 12 CBSE

Chapter 5 - Business Arithmetic . ABC analysis
The inventory control technique known as ABC analysis builds on Pareto's Principle. In ABC analysis, a company reviews its inventory and sorts all SKUs into three categories, called "A" , "B" and "C" items. The typical breakdown might look like this: "A" inventory: 20 percent of SKUs, 80 percent of value. "B" inventory: 30 percent of SKUs, 15 percent of value. "C" inventory: 50 percent of SKUs, 5 percent of value. Pareto's Principle and ABC analysis for control
Whether or not you're familiar with the economic principle known as
Pareto's Principle
, you may have observed its effects. This principle holds that in a given system, a relative handful of "causes" will produce the majority of "effects." For example, one may find that 20 percent of customers are responsible for 80 percent of sales, or that 30 percent of the product lines result in 70 percent of returns. The principle is named for Vilfredo Pareto, an Italian economist who studied land ownership in
Italy in the early 1900‘s and found that roughly 20 percent of the population held title to about
80 percent of the land. Legend has it that he further developed the theory upon observing that 20 percent of the pea pods in his garden produced 80 percent of the peas. For this reason, Pareto's Principle is often referred to as the "80/20" rule.

1. Inventory Control

2. Inventory- meaning The term inventory means the value or amount of materials on hand. It includes raw material, semi-finished goods, spare parts, finished goods. Inventory is required directly or indirectly to make a sale of the end- product and may also represent different stages in the process of getting the final product

3. Inventory control Inventory Control system is expected to achieve desirable behaviour of the inventory items Inventory Control is the process by which inventory is measured and regulated according to predetermined norms such as economic order quantity, lead time, reorder level etc. Inventory control pertains primarily to the administration of established policies, systems & procedures in order to reduce the inventory cost.

4. Objectives of Inventory Control To meet unforeseen future demand due to variation in forecast figures and actual figures. To average out demand fluctuations due to seasonal or cyclic variations. To meet the customer requirement timely, effectively, efficiently, smoothly and satisfactorily.

5. Items that make up the inventory control system Stock- Keeping Unit (SKU)-Unique code based on colour , size, combination of alpha and numeric.(Bar Codes) Motley Crowd – Classified as Raw material, spare parts , Semi-finished goods, finished goods.(One monetary value in Accounting statement) Space-Many bulky items with low value. High value items with low space ( diamonds) Lead time- variations due to standard or special raw material, distance between source and user point

6. Items that make up the inventory control system Standard vs made to order Seasonsal supply Demand not uniform or unpredicatable Shelf life Safety aspects – Special storage (hazardous chemicals) Obsolescence

7. INVENTORY COSTS

8. Important Terms Minimum Level – It is the minimum stock to be maintained for smooth production. Maximum Level – It is the level of stock, beyond which a firm should not maintain the stock. Reorder Level – The stock level at which an order should be placed. Reorder formula = usage rate x lead time Safety stock -Safety stock is the stock held by a company in excess of its requirement for the lead time. Companies hold safety stock to guard against stock-out

9. Types of Inventory Costs Ordering costs- includes paperwork for placing order, receiving, inspection, warehouse handling etc.) Inventory carrying (holding) costs – includes cost of money tied up i.e interest, space cost, insurance etc.

10. Inventory CONTROLModels

11. Economic Order Quantity (EOQ) EOQ is the technique of ordering materials whenever stock reaches the reorder point. Objective is to avoid no stock situation. In this technique, the order quantity is larger than a single period’s requirement so that ordering costs & holding costs balance out.

12. Assumptions of EOQ Demand for the product is constant Lead time is constant Price per unit is constant Inventory carrying cost is based on average inventory Ordering costs are constant per order

13. Basic Fixed Order Quantity Model (EOQ) D = Demand S = Cost of placing order/setup cost H = Annual holding and storage cost per unit of inventory

14. Classification of Inventory Control

15. Pareto’s principle Pareto's Principle This principle holds that in a given system, a relative handful of "causes " will produce the majority of “effects .” For example, one may find that 20 percent of customers are responsible for 80 percent of sales , Pareto's Principle is often referred to as the "80/20" rule.

16. Abc (Always Better Control )analysis The inventory control technique known as ABC analysis builds on Pareto's Principle. In ABC analysis , a company reviews its inventory and sorts all SKUs into three categories, called "A" " B" and "C" items. The typical breakdown might look like this: " A" inventory: 20 percent of SKUs , 80 percent of purchase/consumption value . " B" inventory: 30 percent of SKUs, 15 percent of purchase/consumption value . " C" inventory:50 percent of SKUs, 5 percent of purchase/consumption value .

17. Abc analysis Items in "A" inventory are tightly controlled, meaning the company keeps close tabs on how much it has in stock pays close attention to current demand and forecasts for future demand carefully plans its ordering so that it neither runs out nor winds up with too much excess inventory.

18. Abc analysis Items in "B " inventory are also watched closely, but the company reviews its ordering strategy less often. Since items in "C" inventory are the least expensive, the company can order them in b ulk and exercise minimal controls; all that really matters is that the company doesn't run out . A - outstandingly important; B - of average importance; C - relatively unimportant as a basis for a control scheme