Page 188 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 12: Inventory Management

and “C” according to the potential amount to be controlled. When item have been classified, Notes
appropriate control techniques are develop classified, appropriate control techniques are
developed for each class of inventory. “A” items justify the use of piece control techniques,
where “C” items should be controlled by mean of general control techniques.
The primary criterion for classifying items into “A” and “C” categories is the annual rupees
usage of each item. This is accomplished by multiplying the annual unit usage of each inventories
item by its unit cost and then listing all items in descending order according to annual rupees
usage. This listing should also include C column to show the cumulative annual rupees usage.
Such a listing reflects the distribution of annual rupees usage.

A typical distribution in a manufacturing operation shows that the top 15% of the line items, in
terms of annual rupees usage, represent 80% of the total annual rupees usages and are designated
as “B” items. The “C’ items represent the remaining 70 percent of the items in inventory and
account for only 5% of the total rupees usage. In some cases the ABC classification will be
developed independently for different types of inventory such as finished goods, raw materials
and service parts.
In addition to annual rupees usage, several other factors need to be considered in developing
criteria for analyzing items into “A”, “B” and “C” categories. In this regard, a ‘truth table can be
used to facilitate the classification process. A typical “truth table” is shown below. The question
included in such a table, and the parameter associated with the questions, will vary according to
the specific inventory being analysed.

Table 12.1: “Truth” Table for ABC Classification

Yes Part numbers
Questions Answer
1 2 3 4 5
1. Is annual usage more than ` 10,000? A 1 0 0 0 0
2. Is annual usage between `1,000 and 10,000? B 0 1 0 0 0
3. Is annual usage less than `1,000? C 0 0 1 1 1
4. Is the unit cost over ` 100? B 1 0 0 0 0
5. Does the physical nature of the item cause
special storage problems?
6. Would a stock out result in excessive costs? B 0 0 0 0 1
B 0 0 0 1 0

Classification

In this table six questions are asked regarding each inventoried item. A “yes” answer is indicated
by a one in the appropriate column under the part number; a “no” answer is reflected by a zero.
The column next to the question provides the question provides the key to the classification by
indicating the inventory class associated with a “yes” answer to each question. When there is
more than one “yes” answer per item, the highest classification and inventoried sub-assemblies
are found in the “A” category. Small metal stamping with moderate usage are frequently “B”
items, “C” items are typically hardware items such as small nuts, bolts, and screws.

ABC inventory classification and related control techniques were developed originally for
mutual systems prior to the widespread use of automated inventory record keeping. ABC
control placed emphasis on reducing record-keeping requirements, redirecting clerical and
review effort, and implementing stratified or varying inventory control techniques. These
concepts also are generally applicable to automated systems. They can be used in structuring
exception reports, determining safety stocks, cycling counting programmes and in numerous
other aspects of inventory management and control.

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