Inventory Classification Basics: Supply Chain Optimization

Classifying your inventory is as easy as A, B, C


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Inventory control: Knowing what you have available to ship to your customers or go into production is at the very core of supply chain optimization. One of the simplest and most effective tools in keeping track of what you have is to follow simple rules of inventory classification. 

In companies with thousands of SKUs to track, or companies with limited inventory control resources, it’s impossible to count every SKU, so an A-B-C analysis is used to help assign a tier structure to inventory value.  The purpose is to know which parts you need to keep track of all the time and which you can reconcile once a year. 

A-B-C Inventory Classification

There are multiple ways to approach your A-B-C inventory classification, but for most companies:

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

Some companies use other criteria—like unit cost, supplier lead time, customer importance, and expiration dating—to create their A-B-C tier structure, and some companies blend more than one criteria.  You should be able to export the SKU data you need from your MRP or WMS into Excel and do a simple sort to get your A-B-C classification started. 

Remember, your inventory accuracy objective should be 100 percent, and if you’re not consistently at greater than 99 percent, you need to put your desk in the middle of the warehouse until you are.  

100 Percent Inventory Accuracy

Okay, let’s assume you agree that you need to have 100% inventory accuracy.  How do you measure what your inventory accuracy is right now?  You need to start by counting 100% of your inventory, whether that’s 50 or 15,000 SKUs. 

You might think this process sounds painful, and if your company’s not done it or done it well before, it is.  But like they say in tattooing, you’re not going to get your desired result without some pain.

There are two ways to count your inventory, that is, to assess your accuracy. 

  1. Floor-to-sheet.  Count everything you have in inventory, then compare that to what your system thinks you have.
  2. Sheet-to-floor.  Take the data from your system out into the warehouse and compare it to what you find. 

Floor-to-sheet is the scarier way to go and forces you to be more diligent in your counting.  I recommend starting with a floor-to-sheet count and reconciling it against a sheet-to-floor count. 

Once you complete your physical inventory, you now have a starting point.  Some companies don’t count inventory again until their next physical inventory, which can sometimes be a year later.  I do not recommend this approach.

Cycle Counting

Cycle counting helps maintain inventory accuracy throughout the year and can be handled a couple different ways, depending on the number of SKUs, the value of your inventory, and whether you have the resources to commit to inventory accuracy. 

If your company has 1200 SKUs to manage, you could choose to cycle count 100 each month, which means counting approximately five SKUs each business day.  One or two people can generally do that on a part-time basis. This approach allows you to count every one of your SKUs during the year.  If managed and controlled correctly, this method of cycle counting will help next year’s physical inventory go smoothly.  Some companies that employ this cycle counting methodology do it instead of an annual inventory.  I recommend doing both. 

If you have more SKUs than you can count during a year of normal cycle counting or if you don’t have the people to commit counting everything, you can choose to cycle count only your high-value SKUs. 

Usually 20% of a company’s inventory accounts for 80% of its total inventory value. We referred to this earlier as the A inventory.  If you can’t cycle count 100% of your SKUs during the year, consider cycle counting your A inventory. You’ll still be ahead of the game when it comes time for next year’s physical inventory.

Some Key Points When Considering Cycle Counting

Count the SKUs randomly.  Most MRP or WMS systems (I know the S in WMS stands for “system”) have a cycle count module that provides random SKUs on a daily basis.  A random count helps prevent your warehouse folks from manipulating the SKUs to be counted. 

Keep segregation of duties in mind.  Your cycle counters shouldn’t be the same folks who handle your inventory every day.  This separation helps keep the process and the data clean. 

So, yes, to the question of cycle count or physical inventory: the answer is both.  And by following the steps above, you can do that with negligible impact on your day-to-day operations. Indeed, following these steps can improve your day-to-day operations and get you on your way to optimizing your supply chain.