Inventory control - ABC analysis and basic JIT concepts

Learning Outcomes

After reading this article, you will be able to categorise inventory using the ABC method, distinguish the differing controls appropriate for A, B, and C items, and explain the basic principles of just-in-time (JIT) inventory management. You will understand how these techniques are applied in business to improve efficiency, reduce costs, and why inventory classification is an essential topic for the ACCA FFM exam.

ACCA Foundations in Financial Management (FFM) Syllabus

For ACCA Foundations in Financial Management (FFM), you are required to understand key methods for inventory control. As you revise this article, concentrate on these relevant syllabus areas:

• The objectives of inventory control, including why and how inventory levels are managed
• The use and benefits of ABC analysis for classifying inventory items by value
• How inventory categories influence the focus and extent of management controls
• The main features, aims, and implications of basic just-in-time (JIT) inventory management systems
• How inventory management approaches affect cost control and business performance

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Under an ABC classification system, which inventory group demands the strictest control?
   1. A items
   2. B items
   3. C items
   4. All items equally
2. What is the primary aim of just-in-time (JIT) inventory management?
   1. Maximising physical stock levels
   2. Reducing inventory holding and related expenses
   3. Creating large safety buffers
   4. Holding extra stock for emergencies

3. True or false? In ABC analysis, C items tend to make up the bulk of an entity's inventory value.

4. Briefly state why businesses classify inventory into A, B, and C categories.

Introduction

Inventory control aims to ensure businesses hold the right materials to meet demand but not so much that cash and resources are wasted on stock that is rarely used or of low value. Most businesses have many stock items, but not all are equally important. ACCA FFM requires you to understand classification systems like ABC analysis—used to prioritise controls—and modern methods such as just-in-time (JIT), which focus on keeping stock to a minimum and ordering only as needed to support smooth production and sales.

Key Term: inventory control
The system of ordering, holding, and managing stock levels to ensure demand is met at the lowest cost.

ABC ANALYSIS IN INVENTORY MANAGEMENT

ABC analysis is a method that segments inventory into three groups based on their annual consumption value (price x yearly usage), not physical quantity. This enables tighter controls over the most important items and simplified procedures for the rest.

ABC Categories

• A items: High-value items (often 10–20% of items, but 70–80% of annual inventory value). These require strictest control and monitoring.
• B items: Medium value and usage (often 20–30% of items, representing 10–20% of value). These need standard controls.
• C items: The most numerous but lowest total value (often 50–70% of items, yet only 5–10% of value). These can be managed with the simplest routines.

Key Term: ABC analysis
A classification method that groups inventory into A, B, and C categories according to their annual usage value to prioritise management attention.

Key Term: A item
An inventory item identified as the highest priority based on its high annual usage value, needing tight, frequent controls.

Key Term: C item
An inventory item with low annual usage value, suitable for relaxed controls and infrequent review.

Control Approaches by Category

• A items: Frequent review, regular reorder calculation, management approval required for orders, precise records kept, and tend to be ordered in small quantities to reduce stock levels.
• B items: Routine ordering and monthly or quarterly review. Moderate controls.
• C items: Simple reordering, larger batch sizes, and basic records. Annual counts may suffice.

Why Use ABC Analysis?

Applying the same strict controls to all inventory wastes time and resources. ABC analysis directs efforts where loss, error, or mismanagement would impact the business most.

Worked Example 1.1

A retailer carries 200 different items. On analysis, 18 items account for 75% of the total annual inventory value, 32 items for 18%, and the remaining 150 items for only 7%.

Question:
How should the retailer manage these groups?

Answer:
The 18 items are A items. These should have tight controls, including frequent stock-takes, purchasing reviews, and close supervision. The 32 B items need standard but less frequent controls. The 150 C items should be managed with straightforward, low-cost procedures, such as ordering in larger quantities when needed and infrequent record checks.

Benefits and Drawbacks

• Benefits:

  • Reduces risk and cost for valuable items
  • Minimises unnecessary work on low-impact stock
  • Improves cash use and decision-making

• Drawbacks:

  • ABC analysis does not account for item criticality—some low-value items may still be essential for operations
  • The classification is based only on value, not on lead times or supply risk

Exam Warning

A common error is to assume ABC relates to physical quantity or frequency of use. It classifies by annual value (cost x usage), NOT number of units.

JUST-IN-TIME (JIT) INVENTORY MANAGEMENT

A just-in-time (JIT) inventory system is designed to hold as little stock as possible. Supplies are ordered and arrive exactly when needed for production or sales. This method aims to significantly lower inventory holding and related costs—such as warehousing, insurance, and waste—provided suppliers are reliable and production is predictable.

Key Term: just-in-time (JIT)
An inventory system where goods are ordered and delivered only as required for immediate use, with minimal or zero stock held in storage.

Features and Requirements

• Regular and frequent deliveries from trusted suppliers
• Production is aligned closely with demand, reducing finished goods held
• Little or no inventory is kept between process stages
• Requires excellent communication with suppliers and rigorous scheduling

Advantages and Potential Risks

• Advantages:
  • Releases cash tied in inventory and reduces storage space
  • Quickly responds to changes in demand
  • Lowers risk of obsolescence or spoilage
• Risks:
  • Disrupted supply or transport can halt operations
  • Reliability on a small number of suppliers
  • May need strong long-term supplier relationships and contracts

Worked Example 1.2

A factory previously kept two months’ worth of key component stock. Each month, 800 units are consumed, with a unit cost of $50. Carrying cost per year is 12%. By switching to JIT, the factory agrees with its main supplier to receive weekly deliveries, keeping just one week of supplies on hand.

Question:
What is the change in inventory investment, and what does it mean for the business?

Answer:
Before JIT, stock held was 1,600 units ($80,000). With JIT, only 200 units ($10,000) are held—reducing the investment in inventory by $70,000. Annual holding costs fall accordingly, freeing cash. However, any delay from the supplier can immediately stop production due to minimal stock on hand.

Applying JIT in Practice

Businesses must assess whether supplier reliability is high and if their processes allow for frequent small deliveries. JIT is common where demand and supply are steady and predictable.

Revision Tip

When answering questions, always link ABC controls or JIT features to reduced cost, improved efficiency, or risk—avoid describing the system in abstract terms only.

Summary

ABC analysis enables efficient inventory management by matching control levels to item value. A items get maximum attention, C items minimal. JIT seeks to reduce or eliminate holding inventory, to boost cash flow and reduce costs—but requires high reliability. Both methods aim to make inventory management more effective and cost-efficient.

Key Point Checklist

This article has covered the following key knowledge points:

• Explain inventory control and why items are categorised by value (ABC analysis)
• Describe the main characteristics of A, B, and C items
• Identify and explain the purpose and operation of just-in-time (JIT) inventory management
• Outline benefits and limitations of both ABC and JIT approaches
• Apply inventory management principles to typical exam scenarios

Key Terms and Concepts

• inventory control
• ABC analysis
• A item
• C item
• just-in-time (JIT)