The Importance of Controlling Inventory

The purpose of controlling inventory is to achieve an appropriate balance between holding enough inventory to satisfy customer orders but not holding so much inventory that it negatively impacts the financial performance of the organisation.

ABC/Pareto Analysis

ABC/Pareto analysis is an inventory classification tool which classifies types of inventory from A-C based on its importance and value to the organisation. The classification tool is based on Pareto’s 80:20 rule and advocates that 20% of inventory items make up only 80% of the total inventory value, while the remaining 80% of items account for only 20% of the total inventory value. Therefore, concentrating efforts on the 20% of high-value items will avoid 80% of potential inventory problems.

Figure 2 shows how the Pareto rule is used to determine 3 classes of inventory:

Figure 2: ABC Analysis

From left to right:

A items = high value usage (20% of total items and 80% of the usage value)
B items = intermediate value usage (20% of total items 10% of annual cost)
C items = low value usage (10% of total items 10% of the value)

These percentages can vary from organisation to organisation. Once inventory has been classified, appropriate inventory control measures should be deployed as shown in Table 1:

Item Classification	Control Policy
A Class Items	Tight inventory control Secured storage areas Reliable sales forecasts Frequent reordering Regular reviews
B Class Items	Moderate control Reduced safety stocks
C Class Items	Less control Reduced or no safety stocks Reorder infrequently, possibly only in the event of a stock-out

Table 1: Inventory Classification Control Measures