In large organization, various types of inventories are maintained. All items are not equally valuable so it is not desirable to keep the same extent of control on all items. The more weighted should be given the items whose value are highest. For that purpose, the items should be classified in various categories according to their importance, to ease the controlling.
ABC Inventory Control System deals with the same methodology. Under this system, the items with the highest values are classified in Category A and would be under highest control. Items with lowest value will be considered as Category C and would be under normal control. Whereas, the items with moderate importance will be classified as Category B, and accordingly moderate control will be applied to such items.
This method is also known as the 'Control by Importance and Exception' (CIE) and 'Proportional Value Analysis' (PVA). Following are the steps involved in the process of ABC Analysis:
1) Classify
the items of inventories, determining the expected use in units and the price
per unit for each item.
2) Determine
the total value of each item by multiplying the expected units by its units
price
3) Rank
the items in accordance with the total value, giving first rank to the items
with highest total value and so on
4) Compute
the ratios/% of number of units of each items to total units of all items and
the ratio of total value of each item to total value of all items.
5) Combine
items on the basis of their relative value to form three categories – A, B and
C
Source: Financial Management by I M Pandey, 10th Edition
