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PREFACE OF THE ASSIGNMENT

This assignment is basically depending on the Material Management under


Production and Operations Management. In this assignment I prepared a term
paper on ABC analysis, which helps us to know the control of the material. The
main thrust of this assignment is to know the fact of the Always Better Control
(ABC) analysis in material management—it nothing but the basic analytical tool
which enables top management to place the effort where the results will be
greatest. This assignment is divided into two parts one is theoretical and other is
numerical. In theoretical part I tried to represent the details as well as importance
of the ABC analysis and in the numerical part I tried to give a practical problem
of the ABC analysis. I hope this assignment helps those who are very much
interested to know about the ABC analysis.

ACKNOWLEDGEMENTS
I owe my gratitude to M R Sir, S C Sir and I M Sir, In the preparation of this
assignment I had take their precious suggestions, advantage of the feedback of the
various books available in the library and as well as in internet also. I also expect
some more suggestion from them to improve my forthcoming assignment and
how to improve my skill in the preparation of other projects. This assignment has
made me a better learner, and I hope the readers will entertain similar sentiments
about the book after reading it.

Date: 07/03/2009 Mukesh Kumar Burnwal


MBA/08/98
Sec-B
INVENTORY MANAGEMENT
ABC analysis is a part of the inventory management, before going to
discuss about ABC analysis we need to know about inventory
management and some related topic of inventory management:

INVENTORY: Inventory is a detailed list of those movable items which


are necessary to manufacture a product and to maintain the equipment
and machinery in good working order. The quantity and value of every
item is also mentioned in the list.
Inventory is an idle resource which is usable and has
value. It may be men, money, materials, plant acquisition, spares and
other stocked to meet future demand.

IMPORTANCE OF INVENTORY:

1. Provides and maintains good customer service.

2. Enables smooth flow of goods through the production process.

3. Provides protection against the uncertainties of demand and supply.

4. Various production operations can be performed economically and


independently.

5. Ensures a reasonable utilization of equipment and labour.

6. With purchases in bulk discount can be availed.

7. Adequate controls over materials un-used, used.

There are some selective Inventory control methods to


have an effective control on the inventory.

The important methods are:-

1. ABC Analysis (Always Better Control)


2. VED “(Vital, Essential, Desirable)
3. FSN “(Fast, Slow moving and Non-moving)
4. SDE “(Scarce, Difficult, Easy)
5. HML “(High, Medium, Low) PTO.
Now, I will be going to discuss about Always Better Control (ABC)
analysis.
Always Better Control is an analytical technique for
classification of inventory items was first introduced by an AMERICAN
FIRM- GENERAL ELECTRIC COMPANY. According to this analysis, there are
three categories of inventory items A, B and C type. Depending upon their
percentages of consumption.

The significance of this analysis is that a very close control is exercised


over the items of ‘A’ group which account for high percentage of costs

Less stringent control is adequate for category ‘B’

Very little control would be sufficient for Category ‘C’.

ABC analysis is a basic analytical management tool which enables top


management to place the effort where the result will be greatest. This
technique, popularly known as Always Better Control or the alphabetical
approach, has universal applications in many areas of Human Endeavour.
The technique tries to analyze the distribution of any characteristic by
money value of importance in order to determine its priority. In materials
management, this technique has been applied in areas needing selective
control, such as inventory, criticality of items, obsolete stocks, purchasing
orders, receipts of materials, inspection, store-keeping, and verification of
bills.

The annual consumption analysis of any organization would indicate that


a handful of top high value items-less than 10 per cent of the total
number—will account for a substantial portion of about 75 per cent of the
total consumption value, and these few vital items are called ‘A’ items
which need careful attention of the materials manager. Similarly, a large
number of ‘bottom’ items—over 70 per cent of the total number called the
trivial many—account only for about 10 per cent of the consumption
value, and are known as the ‘C’ class. The items that lie between the top
and bottom are called the ‘B’ category items.

Category % of items % of value


A (High Cost) 10 70
B (Medium Cost) 20 20
C (Low Cost) 70 10
PURPOSE OF ABC ANALYSIS:
Normally, once ABC analysis has been done, the following broad policy
guidelines can be established in respect of each category:
SL. A-items: B-items: C-items:
NO. High consumption value Moderate value Low consumption value

1. Very strict control Moderate control Loose control

2. No safety stocks Low safety stocks High safety stocks

3. Frequent ordering or Once in three Bulk ordering once in a 6


weekly deliveries months month
4. Weekly control statements Monthly control Quarterly control reports
reports
5. Maximum follow-up and Periodic follow-up Follow-up and expediting
expediting in exceptional cases
6. Rigorous value analysis Moderate value Minimum value analysis
analysis
7. As many sources as Two or more reliable Two reliable sources for
possible for each item sources each item
8. Accurate forecasts in Estimate based on Rough estimate for
material planning past data on present planning
plans
9. Minimization of waste, Quarterly control Annual review over
obsolete and surplus over surplus and surplus and obsolete
obsolete items material
10. Individual posting Small group posting Group posting

11. Central purchasing and Combination Decentralized purchasing


storage purchasing
12. Maximum efforts to reduce Moderate Minimum clerical efforts
lead time
13. Must be handled by senior Can be handled by Can be fully delegated
officers middle management

Color coding can be used to identify A, B and C categories in stores.


Usually red is used for ‘A’ items, pink is used for ‘B’ items and blue for ‘C’
items
ADVANTAGES OF ABC ANALYSIS
This approach helps the material manager to exercise selective control and focus
his attention only on a few items when he is confronted with lakhs of stores
items. By concentrating on ‘A’ class items, the material manager is able to control
inventories and show visible results in a short span of time. By controlling the ‘A’
items, and doing a proper inventory analysis, obsolete stocks are automatically
pinpointed. Many organizations have claimed that ABC analysis has helped in
reducing the clerical costs and resulted in better planning and improved inventory
turnover. ABC analysis has to be resorted to because equal attention to ‘A’, ‘B’
and ‘C’ items will not be worthwhile and would be very expensive. Concentrating
on all the items is likely to have a diffused effect on all the items, irrespective of
the priorities.

OBJECTIVE OF ABC ANALYSIS


As discussed earlier, the ABC analysis enables the material manager to exercise
selective control when he is confronted with a large number of items. Tighter and
accurate procedures are essential for ‘A’ value items relating to material planning,
forecasts, ordering, review, records, postings, revisions, lead time analysis, safety
stock, material consumption control, purchase budget, delivery schedule, value
analysis, follow-up, clerical efforts, physical stock verification, receipts, issues,
stores accounting and inspection. The degree control should be rigorous for ‘A’
items and should be minimum for ‘C’ items.
ABC analysis is also helpful to rationalize the number of orders and reduce
the overall inventory. For instance, let us consider three items P, Q, R have been
used and their consumption is Rs. 2,40,000, Rs 24,000 and Rs. 2400 respectively.
Let us presume that ABC classification is not done and annual orders are 12 in
number. Each item will be ordered 4 times and average inventory will be:
ITEMS ANNUAL NUMBER OF AVERAGE
CONSUMPTION ORDERS WORKING
(RUPEES) INVENTORY

P 2,40,000 4 60,000
Q 24,000 4 6,000
R 2400 4 600
TOTAL 2,66,400 12 66,600
Suppose A-B-C analysis followed and the number of orders will be according to the
importance of the items. If the number of orders is 8, 3 and 1, for items P, Q and R
respectively, then the average inventory will be as follows:

ITEMS ANNUAL NUMBER OF AVERAGE


CONSUMPTION ORDERS WORKING
(RUPEES) INVENTORY

P 2,40,000 8 30,000
Q 24,000 3 8,000
R 2400 1 2400
TOTAL 2,66,400 12 40,400
It is thus noted that even though the total number of orders is the same, the average inventory
has been reduced significantly by recognizing that ‘A’ items should be ordered more
frequently.
ABC analysis is illustrated in the following:
A firm has 7 different items in its inventory. The average number of each of these items held,
along with their unit costs, is listed below. They wishes to introduce an ABC inventory
system. Suggest a breakdown of the items into A, B and C classification.
Item number Average number of units in inventory average cost per unit
1 20,000 Rs. 60.80
2 10,000 ,, 102.40
3 32,000 ,, 11.00
4 28,000 ,, 10.28
5 60,000 ,, 3.40
6 30,000 ,, 3.00
7 20,000 ,, 1.30
Solution The A B C analysis is presented in the following table:

Items(1) Units(2) % of total(3) Unit cost(4) Total cost(5) % of total(6)


1 20,000 10 60.80 Rs. 12,16,000 38.00
2 10,000 5 102.40 10,24,000 32.00
3 32,000 16 11.00 3,52,000 11.00
4 28,000 14 10.28 2,88,000 9.00
5 60,000 30 3.40 2,04,000 6.38
6 30,000 15 3.00 90,000 2.80
7 20,000 10 1.30 26,000 0.82
Total 2,00,000 100 32,00,000 100.00
The A B C system of classification should, however, is used with caution. For example, an
item of inventory may be very inexpensive. Under the A B C system it would be classified
into C category. But it may be very critical to the production process and may not be easily
available. It deserves the special attention of management. But in terms of the A B C
framework, it would be included in the category which requires the least attention. This is a
limitation of the A B C analysis.

MECHANICS OF ABC ANALYSIS

The mechanics of classifying the items into ‘A’, ‘B’ and ‘C’ categories is described in the
following steps:

1. Calculate rupee annual issues for each item in inventory by multiplying the unit
cost by the number of units issued in a year. It is assumed that the issues and
consumption are the same.

2. Sort all items by rupee annual issues in descending sequence.

3. Prepare a list from these ranked items showing item no., unit cost, annual units
issued and annual rupee value of units issued.

4. Starting at the top of the list, compute a running total, item-by-item issue value and
the rupee consumption value.

5. Compute and print for each item the cumulative percentages for the item count and
cumulative annual issue value.

The normal items in most organizations show the following pattern:

1. 5 per cent to 10 per cent of the top number of items account for about 70 per cent of
the total consumption value. These items are called ‘A’ items.

2. 15 per cent to 20 per cent of the number of items account for 20 per cent of the total
consumption value. These items are called ‘B’ items.

3. the remaining number of items account for the balance 10 per cent of the total issue
value. These items are called ‘C’ items.

PTO.
ANNUAL COST CUMMULATIVE
ITEM % ITEM COST %
ABC [Rs.] COST [Rs.]
1 90000 90000
10 % 70 %
A 2 50000 140000
3 20000 160000
N 4 7500 167500
20 % 20 %
A 5 7500 175000
6 5000 180000
L
7 4500 184500
Y 8 4000 188500

S 9 2750 191250
10 1750 193000
I 11 1500 194500

S 12 1500 196000
13 500 196500 10 %
70 %
14 500 197000
15 500 197500
WORK 16 500 198000
SHEET 17 500 198500
18 500 199000
19 500 199500
20 500 200000
PTO.

LIMITATION OF ABC ANALYSIS

ABC analysis in order to be fully effective should be carried out with


standardization and codification. ABC analysis is based on grading the items
according to the importance of performance of an item that is by VITAL,
ESSENTIAL and DESIRABLE (VED ANALYSIS) analysis. Some items, though
negligible in monetary value may be vital for running the plant and constant
attention is needed. If the inventory position is analyzed according to the value,
commonly known as XYZ analysis, then result of ABC and XYZ analysis
PTO.
will be different, depending upon the nature of obsolete items. The results of
ABC analysis have to be reviewed periodically and updated. It is a common
experience that a ‘C’ item, like diesel oil in a firm, will become the most high
value item during power crisis. However, ABC analysis is a powerful approach in
the direction of cost reduction as it helps to control items with a selective
approach. The A B C system of classification should, however, be used with
caution. For example, an item of inventory may be very inexpensive. Under the A
B C system it would be classified into C category. But it may be very critical to
the production process and may not be easily available. It deserves the special
attention of management. But in terms of the A B C framework, it would be
included in the category which requires the least attention. This is a limitation of
the A B C analysis.

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