Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate EditionVII. Short−Term Financial
Planning and Management- Credit and Inventory
Management
© The McGraw−Hill^753
Companies, 2002INVENTORY MANAGEMENT TECHNIQUES
As we described earlier, the goal of inventory management is usually framed as cost
minimization. Three techniques are discussed in this section, ranging from the relatively
simple to the very complex.The ABC Approach
The ABC approach is a simple approach to inventory management in which the basic
idea is to divide inventory into three (or more) groups. The underlying rationale is that
a small portion of inventory in terms of quantity might represent a large portion in terms
of inventory value. For example, this situation would exist for a manufacturer that uses
some relatively expensive, high-tech components and some relatively inexpensive basic
materials in producing its products.
Figure 21.3 illustrates an ABC comparison of items in terms of the percentage of in-
ventory value represented by each group versus the percentage of items represented. As
Figure 21.3 shows, the A Group constitutes only 10 percent of inventory by item count,
but it represents over half of the value of inventory. The A Group items are thus moni-
tored closely, and inventory levels are kept relatively low. At the other end, basic inven-
tory items, such as nuts and bolts, also exist, but, because these are crucial and
inexpensive, large quantities are ordered and kept on hand. These would be C Group
items. The B Group is made up of in-between items.CONCEPT QUESTIONS
21.7a What are the different types of inventory?
21.7bWhat are three things to remember when examining inventory types?
21.7c What is the basic goal of inventory management?726 PART SEVEN Short-Term Financial Planning and Management
21.8
FIGURE 21.3
ABC Inventory AnalysisA GroupB Group10080
60
4020
020
4060
80100Percentage
of inventory
valuePercentage
of inventory
itemsC Group
57%10%27%40% 50%16%