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Inventory Classification: Categorizing Stock for Efficient Management

7 Mar 2024

Effective inventory control is the cornerstone of successful retail management. It entails maintaining a precise record of products available on the sales floor and in storage, ensuring optimal stock levels to meet customer demand, facilitating reordering, and enhancing overall profitability.

Disorganization within inventory management can lead to discrepancies between recorded stock levels and actual inventory counts, posing operational challenges. Hence, systematic inventory classification is indispensable for seamless retail operations.

Today, we'll delve into developing and implementing a robust inventory organization system for both sales floors and stockrooms. By establishing a good system, you'll streamline stock counts, mitigate discrepancies, and improve stock replenishment efficiency.

Throughout this discussion, we'll cover essential topics, including:

  • Understanding ABC inventory classification.
  • The methodology behind calculating ABC inventory classification.
  • The benefits and drawbacks of ABC classification.
  • Best practices for inventory classification.
  • Techniques for measuring inventory accuracy.

Let's get started.

What is ABC inventory classification?

Imagine you're running a retail store. You've got tons of products, but not all of them are created equal when it comes to making money. That's where the ABC classification comes in handy.

This method is based on the Pareto principle, which basically says that 80% of your outcomes result from 20% of your efforts. So, with ABC classification, you're grouping your inventory based on the inventory value each product brings to the table. Here's how it usually breaks down:

  • Group A inventory: These are the top dogs, the cream of the crop. They make up about 20% of your inventory, but they're responsible for a whopping 80% of your revenue. These are your best sellers, your big money-makers.
  • Group B inventory: These products are still important, but they're not quite at the top tier like Group A. They make up around 30% of your inventory and contribute to about 15% of your revenue. They're decent sellers, but not as crucial as Group A.
  • Group C inventory: These are the little guys. They make up about 50%, of your inventory, but they only bring in around 5% of your revenue. They're not big money-makers, but they still have their place in your store.

By categorizing your inventory like this, you can focus your efforts where they matter most. You'll know which inventory items drivethe bulk of your sales and which ones might need a little extra push. Pretty neat, huh?

How to calculate the ABC inventory classification

Let's crunch some numbers and figure out how to calculate the ABC inventory classification for your products. It's not as daunting as it sounds, I promise!

  • Determine your total revenue: First things first, you need to know the average inventory cost. Calculate the total revenue generated by each SKU (that's just a fancy term for stock keeping unit - basically, each unique item you sell) over a specific period, usually a year. If you're using a modern POS system or any decent accounting software, you should be able to find this total revenue figure without breaking a sweat.
  • Calculate the contribution percentage: We're going to use a formula to figure out what percentage of your total revenue each SKU is responsible for. Here's the formula:

Contribution Percentage (%) = (Revenue from SKU / Total Revenue) * 100

So, for each SKU, you'll plug in the revenue it brings in and divide it by your total revenue. Then, multiply that by 100 to get the percentage.

  • Categorize your SKUs based on the ABC method: Now comes the fun part - sorting your inventory items into their ABC groups.

Once you've gone through these steps for all your SKUs, you'll have a clear picture of which products are your heavy hitters and which ones might need a little boost.

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Benefits of ABC analysis

Let's talk about why using the ABC inventory classification method can be a game-changer for your business. Here are some key advantages to consider:

More efficient inventory counts and stock orders

By sorting your inventory into ABC groups, you're setting yourself up for smoother inventory management. The beauty of this method is that it ensures your highest-value items are always in check. Take those Group A products, for example. You can keep a close eye on their inventory levels with a regular inventory cycle count. If you're using something like Epos Now, you can even set reorder points and desired inventory levels for these top-tier items. So, when one of these SKUs starts running low, it's a clear signal to shoot off a purchase order to your supplier. Plus, you'll know exactly how much to order to keep your inventory at the optimal level.

Streamlined monitoring of inventory levels

Group B and Group C items aren't left out of the equation either. While they might not be your top earners, they still play a vital role. You can still keep tabs on their inventory levels, just with less frequent cycle counts. Together, these two groups typically make up about 80% of your inventory. Trying to cycle count all of that every single week would be a logistical nightmare for most retailers. But by periodically reviewing their levels, you can strive to maintain inventory accuracy that is as close to 100% as possible.

Prioritizing tasks

With ABC classification, you've got a clear picture of which products are your top performers (Group A), which are decent but not top priority (Group B), and which ones are lower-value items (Group C). This clarity helps you prioritize your tasks effectively.

Optimizing staffing resources

Armed with this knowledge, you can allocate your team's time and manpower more efficiently. Your staff can focus their efforts on managing Group A items, ensuring these top earners are well-stocked, merchandized effectively, and given the attention they deserve. Meanwhile, they can still give attention to Groups B and C, but without over-investing resources.

Balancing workload

By concentrating efforts where they matter most, you prevent wasted time and energy on less critical items. This balance ensures that your team is working smartly and efficiently, maximizing productivity without spreading themselves too thin.

Limitations of ABC classification of inventory

While ABC inventory classification offers significant benefits, it's essential to acknowledge its limitations. Here are some drawbacks to consider:

Not perfectly accurate

One of the main drawbacks of the ABC method is its lack of precision. While it provides insight into the total sales value of each item, it doesn't account for the frequency of sales or turnover rate for a particular SKU. Some low-revenue items may sell quickly and require more frequent reorders, despite their lower overall revenue contribution. Thus, revenue alone may not accurately reflect the popularity or demand for an item. It's important to supplement ABC classification with additional inventory management techniques that consider turnover rates and demand patterns for individual SKUs to address this limitation.

Doesn't consider seasonality

ABC classification primarily focuses on item value or importance but may overlook seasonal variations in demand. Relying solely on this method could lead to overstocking or understocking certain items during specific periods. To mitigate this issue, it's crucial to be mindful of seasonal stock fluctuations and adjust the ABC classification periodically based on changing demand patterns. Items classified as low-value during non-peak times may become more critical during peak seasons, necessitating a flexible approach to classification.

Over-reliance may curb innovation

While ABC classification encourages focus on existing stock, there's a risk of becoming overly fixated on current inventory at the expense of exploring new product categories or innovations. It's essential to strike a balance between managing existing inventory effectively and fostering innovation within your product offerings. By maintaining a forward-looking approach and staying open to exploring new opportunities, you can avoid stagnation and adapt to evolving market trends.

In summary, while ABC inventory classification offers valuable insights, it's essential to recognize its limitations and employ complementary strategies to address them effectively. Flexibility, adaptation, and a balanced approach are key to navigating the complexities of inventory management.

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Best practice for inventory classification

Beyond employing the ABC method for inventory classification, establishing an effective organizational system for the sales floor and stockroom is paramount. When everyone is familiar with the location of specific products, tasks such as restocking shelves, conducting inventory counts, and serving customers become significantly smoother.

Here are two inventory management strategies you can use within a retail environment:

Map out your store and stockroom

The foundation of an organized sales floor and stockroom begins with creating dedicated sections for different product categories. Develop a clearly labelled floor plan for both areas, delineating sections by product type. Display copies of these plans in key areas such as the break room, back office, and stockroom to serve as navigational aids for staff. For instance, in a footwear store, sections may be designated for men's, women's, and children's footwear, with further subdivisions based on function (e.g., lifestyle, running, training).

Clearly label stockroom shelves

Another crucial aspect of retail best practices is the clear identification of products stored in the stockroom and adherence to an organizational methodology. Using our footwear store example, the backstory may feature dedicated sections for men's, women's, and children's footwear (Tier 1), with further organization by shoe type (Tier 2) and finally by SKU (Tier 3). It's imperative to accurately categorize and label these sections on the store map, ensuring consistency among staff members. By adhering to this plan, the risk of stock discrepancies due to misplaced or lost products is significantly reduced.

By storing products in defined areas and ensuring adherence to the established organizational structure, retailers can streamline operations and enhance inventory management efficiency. Consistency in placement and adherence to the designated plan are crucial to maintaining order and maximizing productivity.

How to measure inventory accuracy

Measuring inventory accuracy is crucial for effective inventory management. Here's a step-by-step guide on how to do it:

  • Perform a physical inventory count: The first step toward measuring inventory accuracy is conducting a comprehensive physical inventory count. This involves counting 100% of the inventory you have on hand in both your sales floor and stockroom.
  • Utilize the floor-to-sheet method: During your stock take, meticulously count the inventory per SKU in your sales floor and stockroom. Ensure accurate counting and record your findings using pen and paper or an Excel spreadsheet. Then, compare your inventory count results with the records from the inventory management integrated into your POS system
  • Identify discrepancies: If there's a mismatch between your physical count and your POS system's records, you've encountered a discrepancy indicating inaccurate inventory. If your count shows fewer items than your retail POS, it suggests losses due to shrinkage. Conversely, if your count exceeds your POS report, it may indicate double scanning errors during transactions.
  • Balance inventory levels: Reconcile the differences between your physical count and retail POS system records to establish an accurate inventory level. This process involves adjusting inventory counts to reflect the actual quantities on hand.
  • Cycle count Group A inventory regularly: Since Group A inventory contributes significantly to revenue, prioritize regular cycle counting of these items to maintain accuracy. Regular checks help minimize discrepancies and ensure that your high-value inventory is accurately accounted for.
  • Cycle count Group B and C inventory: While it's essential to cycle count all inventory groups, prioritize Group A due to its revenue contribution. Group B and C inventory can be cycle counted less frequently, considering their lower impact on revenue.
  • Schedule full inventory counts strategically: To streamline the process and minimize disruption to operations, schedule full physical inventory counts during periods of low SKU levels. Many retailers opt to schedule these counts during post-holiday lulls or at the end of July when SKU levels are typically lower.

By following these steps and implementing regular cycle counting practices, you increase the likelihood of achieving 100% inventory accuracy and minimizing discrepancies in your inventory management system.

Final thoughts

In conclusion, classifying your inventory is essential to prevent discrepancies and maintain operational efficiency. While there's no one-size-fits-all approach to inventory classification, establishing a logical and systematic method for organizing SKUs and product types is crucial. Whether you organize by season, brand, or product type, the goal remains the same: to effectively track inventory, ensure accurate counts, and maintain optimal stock levels. By implementing inventory classification strategies, retailers can benefit in several ways:

  • Routinely track inventory levels: Classifying inventory enables retailers to closely monitor the levels of their most profitable SKUs, ensuring they are adequately stocked to meet customer satisfaction and demand. Frequent monitoring is key here!
  • Accurate physical inventory counts: A systematic classification system facilitates accurate physical inventory counts, reducing discrepancies between recorded and actual inventory levels.
  • Maintain ideal inventory levels: With organized inventory classification, retailers can better manage stock levels across all SKUs, minimizing overstocking or understocking situations.
  • Minimize discrepancies: Proper inventory classification helps minimize discrepancies resulting from lost or misplaced items, improving overall inventory accuracy.
  • Increase employee efficiency: A well-organized inventory system simplifies tasks for employees, allowing them to locate items quickly and efficiently, ultimately boosting productivity.
  • Maintain an organized sales floor: Organizing inventory on the sales floor enhances the shopping experience for customers and presents a professional image for the store.

Consider experimenting with different inventory classification methods to find what works best for your retail store. Whether it's organizing by season, brand, or product type, the key is to establish a system that aligns with your store's unique needs and enhances overall efficiency. Good luck implementing these strategies, and may they contribute to the success of your retail endeavors!

Liked this blog? Then check out our additional inventory resources including our blog on how to calculate end of year inventory and our guide on inventory forecasting.


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