ABC analysis is applied to stock and its management. It is based loosely on the Pareto principles,
better known as 80/20 rule. Pareto principle is the theory that 80% of outcome results from 20% of
inputs. For example, 80% of sales are to the top 20% of customers; 80% of spend on inventory is
accounted for by the top 20% of stock items.
The ABC concept is based on Pareto's law. The following steps are carried out for the ABC analy-sis.
- Step 1: Compute the annual usage value for every item in the sample by multiplying the annual
requirements by the cost per unit.
- Step 2: Arrange the items in descending order of the usage value calculated above.
- Step 3: Make a cumulative total of the number of items and the usage value.
- Step 4: Convert the cumulative total of the number of items and usage values into a percentage of
their grand totals.
- Step 5: Draw a graph connecting cumulative % items and cumulative % usage value. The graph is
divided approximately into three segments, where the curve sharply changes its shape. This
indicates the three segments A, B and C.
LO 2, AC 2.1
