Any organization usually deals with lots of items.

It is very difficult to exerc ise control over all the items. Controlling means transactions related to invent ory, degree of control, type of records to be maintained, lot sizes, frequency o f review, size of safety stock to be maintained etc. ABC analysis helps to classify the thousands or even millions of ind ividual items into three groups namely items belonging to A group, B group, C gr oup items respectively. ABC analysis is done based on the Pareto s principle. Cons umption value is the basis for ABC classification. Consumption value is the prod uct of unit price and consumption.

Mechanism of doing ABC classification: Steps involved: 1. Collect previous year consumption and unit price for each item 2. Multiply the consumption and unit price for each item to get the consumption value 3. Rank the items corresponding to the consumption value 4. Calculate cumulative consumption value against each item 5. Find the percentage of cumulative consumption value.

Usually to classify the items into A class there is leverage available. The levera ge is 60 to 70 percentage of consumption value. This means you can fix the cut-o ff value in between 60 to 70 percentage of consumption and the corresponding ite ms which contribute up to the cut-off value are classified as A class items. Similarly to classify the items into B class, there is a leverage of the consump tion value to the extent of 10 to 20 percentage of consumption value. To classify the items into C class, there is a leverage of the consumption value to the extent of 10 to 20 percentage of consumption value.

Table 2.1 Class of items Cut-off % of consumption value A 60-75 B c 10-20 5-10

Advantages of ABC analysis: 1. Better exercise of control over all materials 2. The capitol invested in inventory can be reduced to minimum levels 3. Warehouse and storage costs can be reduced

Limitations of ABC analysis: ABC analysis mainly provides a guideline for inventory management. It needs to be supplemented by basic understanding and judgment as there are certain item s which may fall into category C or category B due to their low usage value but are otherwise very critical for the production process of the firm. Their invent ory levels have to be carefully monitored. The ABC analysis, to be effective, needs to be constantly undertaken and per iodically reviewed by management, as the number of items and value of items keep on undergoing change over time. The practical problem in the use of ABC analysis is that generally thousands of items fall in category C, as a result a lot of time is spent on managing inv entory of items of this category (even if it needs simple control). The time lef t for controlling the inventory stocks of categories A and is therefore much sho rter than that required for their effective management