In order of their estimated importance. Consequently, 'A' items are very important, 'B' items are important, and 'C' items are marginally important. The organization gives 'A' rating to their best customers since they yield the highest revenue. Sales managers serve them. 'B' rated customers (with more attention) would then follow and lastly 'C' customers whom warrants less attention and are served accordingly.
Advantages of ABC Analysis
ABC analysis provides the materials manager with opportunity to exercise selective control. Thus, the manager will only focus on a few items despite a possible confrontation with a numerous stores of items. When the material manager resorts to concentrate on 'A' Class items only, he is in a better position to control inventories and show tangible outcomes in a short span of time. ABC analysis has helped in reducing clerical costs. Such analysis when applied to various organizations has resulted into better planning and improved inventory turnover (Swamidas, 2000, p. 32). The analysis dictate that the three class items, a, B, and C. ca never enjoy equal attention since it will be worthless and uneconomical. Apart from the costly nature of equal analysis and attention to the three class items, concentrating on all the items will have a diffused effect on all the items, irrespective of the precedence.
Customers who buy the largest quantities of the products are the least in numbers, hence account for the biggest portion of the company's revenue. 'B' customers would then follow characterized by relatively larger number though only manages smaller portions of the product at a given period compared to group 'A'. However, they still manage to catch the attention of the sale assistants who occasionally serve those (Swamidas, 2000).
The customers belonging to group 'A' enjoy not only the benefits of large scale purchases but also most attention given to them by managers of the company with special treatment given to the because only the sales managers serve them. They also enjoy special privileges given their strong connection with the management of the company with majority of them belonging to social class similar to that of managers and senior executives of the company. In essence, economic power displays out in terms of quantities that a given individual will purchase at a given time (Swamidas, 2000). Customers belonging to group 'C' constitute the majority of the buyers though minority in terms of quantities purchase after a given period. Due to their meager income, they do not purchase products in large quantities. Hence, do not enjoy special treatment as well as privileges contrary to group 'A' and 'B'. Customers belonging to category 'C' purchase the products in very low quantities.
Economic Order Quantity
Economic order quantity (EOQ) is the order quantity used to minimize the total holding and ordering costs annually. The Economic Order Quantity model gives a good indication of whether or not current order quantities are reasonable. The following are assumptions regarding the economic order quantity: The Economic Order Quantity (EOQ) is relatively uniform and has known demand rate, it has fixed item cost, fixed ordering and holding cost, and a constant lead-time. The model is applicable when the demand for an item shows a constant or almost constant rate when the entire quantity that is ordered arrives at one point in time. According to David Anderson and Dennis Jay, the average inventory is half the maximum inventory or 1/2 Q. During the production run, inventory buildup occurs and constant depletion rate occurs during the non-production period. Therefore, the average inventory would be one-half the maximum inventory. However, the production lot size Q. In this inventory system, does not go into inventory at one point in time. Hence, the inventory will hardly reach a level of Q. Overall; the Economic Order Quantity represents the optimum order quantity a company should rightfully hold in its inventory considering the set cost of production, rate of demand among other variables.
Formula of Economic Order Quantity (EOQ)
Different formulas already developed for calculating the Economic Order Quantity (EOQ). The following formula is applicable in the calculation of EOQ.
A = Demand for the year
Cp = Cost to place a single order
Ch = Cost to hold one unit inventory for a year
Alternatively,
Where:
S = Setup costs
D = Demand rate
P = Production cost
I = Interest rate (considered an opportunity cost, so the risk-free rate can be used
Inventory Model with planned Shortages
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