Inventory Classification

20 - 30 year old female worker pulls box off of warehouse shelf
Bob O'Connor/Stone/Getty Images

In the warehouse, there can found different types of inventory. The items can be fast-moving stock that is sold almost as fast as it is produced, items that are high-value items that are not sold frequently, and some inventory that is somewhere in between. It is beneficial for a business to classify the inventory in their warehouse so that they can make decisions based on the type of inventory they have.

Many companies use some kind of ranking system to classify their materials in the warehouse, such as the ABC classification.

Classifying Inventory

The first attempts at classifying inventory in the warehouse were made by the General Electric company in 1951. It was suggested by one of their employees, H. Ford Dickey to classify items based on sales volume, lead-time, cash flow, or stockout costs. His suggestion was to use a classification tool called ABC analysis. The process would assign an item to a group, designated by the letter A, B, or C, based on the parameters that are defined for that group. The A group would contain items that have the highest impact for the company, while the C group would contain items with the lowest impact. Depending on the parameters defined for each group, the item could be assigned to a different group.

The way in which the ABC analysis was performed was based on Pareto's Law, which detaches the "trivial many" from the "vital few".

For inventory classification, this means that there are a small number of items that have the biggest impact on a company, while most of the items in the warehouse have far less impact.

ABC Analysis

When ABC analysis is used in the warehouse, the logistics department will make decisions on the parameters for the different groups.

Some companies will use more than three groups if there is a need for a greater distinction of the inventory. This may be the case for companies with large inventories and complex cycle counting requirements.

The general rule of thumb for classifying inventory is that:

  • Inventory in group A accounts for about 20 percent of the items in the warehouse and 80 percent of the dollar usage
  • Inventory in group B accounts for about 30 percent of the items and 15 percent of the dollar usage
  • Inventory in group C accounts for about 50 percent of the items and 5 percent of the dollar usage

Some companies will not use dollar usage but will use other criteria such as transaction usage, unit cost, lead time, and carrying costs.

Performing an ABC Classification

When a logistics department has made their decision on the parameters that will make up the A, B, and C groups, then it is possible to perform the ABC classification process. There are many ways to perform the process, by using your ERP application, your inventory control system, or download data to an Excel spreadsheet. When the calculations have been made, and the items assigned to their relevant groups, there needs to be review by the logistics department.

With any calculated value, there may be an anomaly that causes an item to be assigned to group B, when it is an important item to the company and should be in group A. Similarly, a slow-moving item that may have seen unusual sales activity could be in group B, when it should be in group C. It is up to the logistics department to make some subjective decisions on the ABC process in order to produce the most accurate classification.

Counting Inventory

Once of the most common uses of the ABC inventory classification is for counting inventory. Cycle counting is very commonly used in the warehouse to ensure that fast-moving stock or stock most important to the business is regularly counted, while inventory of less import is counted less frequently. ABC assignments are used to trigger counts on certain items.

For example, items that are in group A may be counted every month, while items in group C may be counted every six months.