Inventory methods

Inventory; What a topic to start this year 2014, but, for so many companies the last section of the year and the beginning of the new campaign is devoted to this tedious but essential task.

Inventory is a necessary evil in any organization, therefore we couldn´t let the year end without dedicating a post to thistask.

Every unit of inventory has an economic value and is considered an asset of the organization irrespective of where the inventory is located or in which form it is available. Primary focus should be placed in maintaining optimum levels avoiding lower lever but also the excess of wares.

After this brief introduction let’s skip the preambles and focus on the main objective of this post, to shed some light over the several existing inventory classification methods.

           ABC classification

In most of the organizations inventory is categorized according to ABC Classification Method, which is based on Pareto principle.

The ABC method provides a mechanism for identifying which items have the biggest impact on the overall inventory cost, implying this merchandise should be categorized and hence managed and controlled in a different way.

The ABC method group the merchandise in three different categories:

A – Items are very import for the organization due to their high value. This items requires tight control and frequent value analysis.

B – Items are important but less important that items A. These items should be controlled but not comprehensive control is needed.

C – Items are marginally important.

  
Based on the experience and the data collected in most cases the conclusion reached is that 20% of the inventory accounts for 80% of the annual activity. Following this reasoning the

Items A – Approx. 20% of the Items account for 80% of the consumption value
 

Items B – Approx. 30% of the Items account for 15% of the consumption value
 

Items C – Approx. 50% of the Items account for 5% of the consumption value

Whereas there are no fixed percentages, and they may vary depending on the company´s discretion, these are the most commonly applied.

XYZ classification

XYZ inventory system is very similar to the ABC but they differ in an essential point, whereas ABC method structures the wares in terms of value and quantity, the XYZ method is more used in relation with the consumer demand for finished goods.

Items X - Are highly demanded goods

Items Y - Medium demanded products

Items Z - Products with very low demand.

The company will again have to decide the number of items included in the clusters but the percentages used in the ABC method can be successfully applied in the XYZ method. 

HML classification

Again HML method is similar to the ABC and the XYZ analysis except that the items under this method are classified based on their unit prices. The goods are categorized in three groups:

Items H – High price items

Items M – Medium price items

Items L – Low price items

        

VED classification

While in ABC classification inventories are classified on the basis of their consumption value and in HML analysis the unit price is the basis, criticality of inventories is the basis for VED analysis.

Items Vital - Items critically needed. Production will come to halt unless they are available at all times.

Items Essential – Itemswith lower criticality but whose stock out is very high.

Items Desirable – Items with the lowest criticality which won´t cause immediate loss of production.

Overall, the VED analysis is used to determine the criticality of an item and its effect on production and other services.

                SDE classification

SDE inventory method is based on the purchasing availability of the items.

Items S – Scarce material; material that is hardly available or requires longer lead time, generally imported items.

Items D – Difficult items; goods that are difficult in sourcing, either because they have to come from distant places or because the unreliability of the supplier.

Items E – Easy material; material easily available.

Commonly, it´s the purchasing department which classifies the materials based on level of difficulty in sourcing.

FSN classification

This method classifies items on the basis of their movement from Inventory. Here the items are classified as:

Fast – Items that are frequently used

Slow – Items that are used less for certain period of time

Nonmoving – Items that are not used for more than certain duration

The higher the average-stay of an item in the warehouse, the slower is its movement from inventory.

This method helps to establish a proper warehouse layout by locating all the fast moving items near the picking area.
 

SOS classification

This inventory method has been conceived based on the nature of the items and period of their availability. It classifies all the items into two categories

Items S – Seasonal materials. Can be further classified into two groups:

-          Seasonal items available only for a short period of time during the year, (tropical fruits for example) the purchasing department will have to plan the requirements in advance.

-          Materials that are seasonal but are available throughout the year (grains for example). Despite this products are seasonal, they don´t behave as the common seasonal goods.

Items OF – Off seasonal materials, are available throughout the year without any significant price variation.

GOLF classification

This method classifies the items based on the nature of the purveyors. 

Items G – Government controlled supplies

Items O – Open market supplier

Items L – Local supplier

Items F – Foreign market supplies.

As we have seen, there are several methods used to control inventory and each method highlight a different aspect. The right method should be selected depending on the nature of the items and the purpose of the business.