Inventory management, especially small business inventory management, is one of the most overlooked aspects of running a business, yet one of the most crucial. In order for your company to be successful, you should know exactly what products you are working with, the quantities you have, and how to manage each type of product so that you get the most out of them.
Not all products are made the same, and if you think about it, you’ll see that some of your goods are certainly more valuable than others. How do you categorize them? And how can you develop a strategy based on this separation?
The ABC analysis tries to answer some of these questions. This method to optimize inventory is widely popular and can make a true difference in your small business inventory management.
The ABC Analysis
The ABC analysis is an inventory classification method which divides your products into 3 categories, by order of importance. The 3 categories are usually named A, B, and C, where A products are the most valuable and C are the least valuable. For this reason, A-items are sometimes called the critical few and C-items are called the trivial many.
But how do you divide your inventory into types A, B, and C? Well, first of all, we need to talk about the Pareto principle.
You’ve probably heard about Pareto’s principle, also called Pareto’s rule, the 80/20 rule, or the law of the vital few. It is applicable to many areas and states that 80 percent of the effects come from 20 percent of the causes. If we apply this principle to small business inventory management, it means that roughly 80 percent of your inventory value corresponds to only 20 percent of your products.
As you’ve probably guessed, these 20 percent correspond to A-items. The remaining 80 percent of your products are the B and C items. B-items can be about 30 percent of your total inventory, while C items make up the remaining 50 percent.
It’s up to you to determine which are your A, B, and C items based on your sales data, and which products are responsible for 80 percent of your total sales value. Remember that this is not set in stone, as percentages may vary slightly. The true objective of this analysis is to develop strategies to manage each product according to its importance. Products may also switch categories as their life cycle evolves.
ABC Management Policies
As we’ve said, the ABC analysis is not just for show. The goal here is to have different management policies for each type of product in your inventory. Obviously, the more common C-products are not going to have the same treatment as valuable A-products. Let’s take a look into this in a bit more detail.
A-items should be tightly controlled, with frequent inventory audits to make sure that everything is running smoothly. They should be stored in the most secure and conditioned place possible, in order to preserve their numbers and integrity.
Running out of stock on A-items can be a huge blow to your business, so this should be avoided at all costs. So, monitor stock levels closely and reorder well ahead of time to prevent any setbacks. A modern inventory management system or inventory control app can do this automatically. Forecasts for A-items should also be as accurate as possible, so use a reliable sales forecasting app for that purpose.
On the other hand, C-items don’t need to be monitored so closely. You should also consider the cost of having too many C-items in your inventory. As they account for a lower volume of sales, the risk of overstocking is higher, which may cause you to lose money. Instead, you can always understock and reorder if necessary, because C-item sales are not critical.
B-items are somewhere in between A and C-items. You should keep an eye on B-items and their potential evolution to A-items, which would happen in the early stages of the product lifecycle, and to C-items, nearing the end of the life cycle.
One of the challenges with small business inventory management and ABC analysis is that it is not static, as we have already seen. B-items are the ones you should pay more attention to, but A and C-items may also change in importance as market trends come and go.
This prediction has been increasingly difficult in recent years, especially with the rise of e-commerce platforms that can easily lead to spikes in sales, causing a B-product to quickly transform into an A-product if there are shortages in inventory. To diminish the risk of these unforeseeable events, it is really worth it to invest in an accurate forecasting tool for small business. Good luck!