ABC analysis: how to find out what the business earns the most

2024 Author: Malcolm Clapton | [email protected]. Last modified: 2023-12-17 03:44

You will be able to determine on what products and customers you earn the most, what and whom you can easily refuse, who owes you the most, and to whom you.

Dmitry Furye Consultant of Neskuchnye Finansy company.

According to the Pareto principle, 80% of business profits come from 20% of goods. If you have an online store, you earn 80% of the profit for 20% of the assortment. Let's talk about a method that will help you quickly and accurately identify the same 20%.

The essence of ABC analysis

Take a stationery store. To keep things simple, we will limit the assortment to 10 items.

We get just such a table.

Stationery store assortment for ABC analysis

Product	Profit, rubles
Fountain pens	150 000
Markers	200 000
Ruled notebooks	50 000
Checkered notebooks	45 000
General notebooks	30 000
Drawing books, A4	15 000
Notepads	20 000
Notebooks	5 000
Diaries	3 000
Pencil cases	10 000

Then we proceed in the following sequence:

1. We sort the goods and the profit they bring to us in descending order. You don't need to do this manually - a smart electronic sign will handle it on its own.
2. We calculate the share of each product in the total profit of the business - this is column 3 "Share in the total profit" in the table below.
3. And now the most interesting thing: from product to product, we consider their total share in profit as a cumulative total. The share of markers that took the first place in terms of profit is 33.78%. In second place are fountain pens with 28, 41% profits. Together, these two products generate 66.29% of the profit for the business. Etc. Ask - why, after all, it is already known that in the end it will turn out to be 100%? And the fact of the matter is that we are interested in intermediate values. After all, we want to know which goods form 80% of the profit and what is the role of the rest. The answer is in the table that we got. We see the share of individual products in the third column. But by itself, she still does not say anything. We sort products into groups according to their total profit share. The smart sign calculates this cumulative share in the 4th column "Total share".
4. And last but not least, we sort the products into groups. Everything that is less than or equal to 80% in total is group A. These are the main “breadwinners” of the business. As soon as we have reached the threshold of 80%, the first product, the total share of profits with the participation of which exceeds 80%, belongs to group B. In our example, these are squared notebooks. They increase the total share of the company's total profit from 75.76% to 84.28%. When the next product increases the total profit share to 95% or more percent, this is already the first product from group C. In our example, these are sketchbooks - after them the total profit share increases to 96.59%. All that remains is also Group C.

As you can see, the store makes 75, 76% of its profits on markers, fountain pens and ruled notebooks. Squared notebooks, general notebooks and notepads bring business 17.99% profit. The remaining four positions are 6.25%.

In the classic version of the ABC analysis, the ratio between groups A, B and C is 80/15/5. 20% of the profits that the business, according to the Pareto principle, receives from 80% of the goods, are additionally detailed in the ABC analysis - 15/5.

We got a different ratio - 75, 76/17, 99/6, 25. It's okay. The realities of business do not always fit into the classics. The main thing is that the total amount is 100%. This is a self-test.

A + B + C = 100%.

In the classic version: A = 80%, B = 15%, C = 5%. A / B / C = 80/15/5.

In our example: A = 75.76%, B = 17.99%, C = 6.25%.

75, 76% + 17, 99% + 6, 25% = 100%. So everything is correct.

The result of the ABC analysis

After the ABC analysis of the assortment in terms of revenue or profit, we will see which products are worth focusing on. We pay maximum attention to products that sell well and bring the main money to the business. What to do with the rest, especially outsiders bringing in the least revenue / profit, is a reason to think hard.

We have sorted products into three groups:

1. Group A. Leaders - 80% of sales, 20% of resources.
2. Group B. Solid average peasants - 15% of sales, 20–35% of resources.
3. Group C. Outsiders - 5% of sales, 50-60% of resources.

Information about which group the product belongs to is the basis for making decisions.

Products from group A must always be in stock. The shortage of goods of group A is a drawdown in revenue. As a result of the ABC analysis, we received a ready-made list of such goods. This list can be compared at any time with the current situation. And if necessary, buy the missing goods on time.

But to make large stocks of goods of group C - only to freeze profits in them. You can safely refuse goods from group C or deliver them on order. It is up to the owner to decide whether he needs a product from group C.

When a business owner wants to know exactly how much of each product from group A should be in stock, ABC analysis is no longer an assistant. There is a separate tool for this called XYZ analysis. But this is a topic for a separate article. In any case, you need to start with the ABC analysis.

It is useful to conduct an ABC analysis of the assortment separately for two indicators - revenue and profit - and compare the results. A common case is that goods from group A in terms of revenue turn out to be in group B or even C by profit. But goods from group A in terms of revenue, in any case, provide an inflow of money to the company and are therefore important. When the owner has identified such a product, there is reason to think. Perhaps there are ways to make it more profitable. And if you abandon the goods of group C in terms of profit, then those of them that are in group A in terms of revenue are the last.

If you do not perform ABC analysis on both indicators, there is a danger of focusing on the wrong one. Or refuse a product that would be worth keeping.

Other uses for ABC analysis

ABC analysis is applicable not only to assortment. Recently, we did it on the basis of revenue for a transport company. The owner was developing a loyalty program and wanted to know who to include in it. To do this, information was needed how much percent of the revenue each client brings him and how clients are distributed between groups A, B and C.

In this case, the places of goods in the table were taken by customers and the revenue that each of them brings to the business. Such a table will look, for example, like this (all names and indicators are fictitious, possible coincidences with real ones are random).

The name of the company	Revenue, rubles
LLC "Ural Prostory"	300 000
LLC "South Ural Logistics"	500 000
CJSC "Expert Solutions"	100 000
SP. Ivanov I. I.	50 000
IP Petrov P. P.	70 000
SP Sidorov S. S.	30 000
JSC "Fresh products"	200 000
Total	1 250 000

After the ABC analysis, the table will look like this:

Now the owner knows on which of the clients he makes the most money, which of them is the middle peasant in terms of the proceeds that he brings to the business, and who is the outsider.

The business owner will offer the loyalty program to his clients from group A, in the retention of which he is most interested. And clients from group B with the help of the loyalty program will be stimulated to make more orders and move to group A. He continues to work with clients from group C. But there is no point in offering them participation in the loyalty program.

ABC analysis rules

1. It is necessary to conduct an ABC analysis for one indicator that can be measured in money. This can be revenue, profit, purchase amount, accounts receivable (everything that the business owes) or payables (everything the business owes). All objects of ABC analysis should be tied to numbers: how much revenue or profit each product or client brings, how much the business earns from each supplier or how much we buy from each supplier, how many receivables hang on each debtor, how much the business owes each creditor.
2. The objects of ABC analysis can be individual goods or groups of goods, customer base, supplier base, debtor base, creditors base.
3. ABC analysis is carried out within the boundaries of one direction. When a business sells cars, parts and repairs cars at the same time, these are three separate areas. It makes no sense to put cars and spare parts in one plate. These are goods of different price categories and frequency of consumption: we change cars every few years, and we buy spare parts for cars much more often. The objects of ABC analysis should have comparable parameters.
4. Typically, ABC analysis is carried out to adjust strategic business plans. In such cases, it is held once a year, and the data is updated quarterly. But if the goal is to increase the average check, you can use ABC analysis once a month. This approach will allow you to see how management decisions are reflected in the distribution of profits between groups and categories.

Conclusion

ABC analysis is a tool with which you can sort products, customers, debtors and creditors into leaders, middle peasants and outsiders. Find out on whom and what you earn the most, what and whom you can easily refuse, who owes you the most, and to whom you.