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Reducing Excess Inventory

Apr 9, 2019

The five advantages of an effective ABC analysis

After you’ve spent time working out your inventory control processes, you can begin to improve your inventory in other ways. By leveraging the useful transaction data in your ERP system, you can better understand the value of your items beyond that of costs and margins.

We recommend you institute item classification to help you focus on the most important items. Here’s a quick example of how Sage Inventory Advisor provides item classification via an ABC analysis:

Sage Inventory Advisor gives you a clear look at both the cost and velocity of your items, so you have a fuller understanding of your inventory items. Why is this so important? Here are the top five reasons why this kind of inventory analysis will help your business.

1) Fight fewer fires

You have to choose your battles.

This old adage is also true in your inventory. You cannot fight every fire that pops up every day. But how do you choose your battles in managing inventory? A good place to start is with the ABC analysis.

Don’t waste your time on the unimportant items. Instead, spend your limited time and energy on the items that really make a difference in your business: the A items and the High Velocity items.

And the good news is that the important items are normally only the top 20%. You can definitely fight 20% of the fires, and that means you’ll combat 80% of the problems.

2) Invest working capital on products that deliver sales

Inventory management would be easy if we had infinite working capital to work with. You could stock as much inventory as was needed to get a 100% fill rate on all items.

But in the real world, that’s just a pipe dream. You have real working capital constraints that must be considered. Deploying that working capital properly can make the difference between mediocre sales and shooting the lights out.

By now, you’ve probably guessed that you can use your ABC analysis to achieve this. Looking back at the Matrix, it’s easy to see that there’s no point investing huge amounts of capital into the C-Low velocity items: they simply don’t contribute much to the bottom line.

Instead, you should invest most of your working capital into the A-High velocity items. Not only will they make a lot of sales and profit, but they also move quickly, turning your money over faster.

3) Manage important items more closely

So you have an item flagged as a Potential Stock-out. Depending on its classification, your reaction will be very different: C-Low velocity items can basically be ignored, at least until a later time. A-High velocity items, on the other hand, should be managed immediately.

The opposite is also true. When an item gets flagged as having Surplus Purchase Orders you will respond in one of two ways, depending on the classification. C-Low items must be managed immediately. Cancel the order if you can, because those extra items will sit in your warehouse for a long time, and they won’t make any profit when they are eventually sold.

However, if you ordered too much of a High Velocity item, it may not be a huge problem – those items move quickly, after all. You should only worry about these items if you ordered a few months’ worth of extra units. But an extra week or two of High Velocity items really doesn’t matter.

4) Let an automated system manage less important items automatically

If you get the forecast wrong by 20% on an AH item, it’s a really big deal. But there are probably thousands of items where a 20% forecast error is not even a blip on the radar screen.

Let an automated forecast engine take care of those items for you. Spend your precious time on the items that really matter.

5) Profit!

By investing your working capital wisely into the items that give the highest return on investment, and by spending your precious human energy on the items that matter, you are guaranteed to make more profit.