The correct answer is (E) annual dollar volume. ABC analysis, also known as ABC classification or Pareto analysis, is a widely used inventory management technique that divides on-hand inventory into three classes based on their annual dollar volume.

This classification method helps organizations prioritize and manage their inventory more effectively by identifying and focusing on items that have the most significant financial impact. Let’s delve into why this answer is correct and then explore why the other options are not suitable in this context.

E. Annual dollar volume:

ABC analysis categorizes items based on their annual dollar volume, which is essentially the annual monetary value of each item. This means that high-value items, those that contribute the most to a company’s revenue or inventory cost, are classified as “A” items, while lower-value items are categorized as “B” or “C” items.

The idea behind this classification is to allocate more attention, resources, and management focus to the high-value items (A items) because they represent the most significant financial impact on the organization.

By concentrating efforts on these crucial items, a company can optimize its inventory management and ensure that these items are well-stocked and readily available to meet demand.

Now, let’s examine why the other options are not correct in this context:

A. Item quality:

ABC analysis primarily focuses on the financial impact of items rather than their quality. While item quality is undoubtedly an important consideration in inventory management, ABC analysis is specifically designed to prioritize items based on their contribution to revenue or cost. It’s a financial classification method, not a quality assessment tool.

B. Unit price:

Unit price is related to the cost of individual items, but it’s not the primary basis for ABC analysis. While the cost of items is an important factor, ABC analysis considers the annual dollar volume, which takes into account both the unit price and the quantity of items sold.

High-priced items may have a significant unit price, but if their annual demand is low, they might not have a high annual dollar volume, and, therefore, may not be classified as “A” items.

C. The number of units on hand:

The number of units on hand (inventory quantity) is not the primary criterion for ABC analysis. While inventory quantity is important in inventory management, ABC analysis focuses on the monetary value of the items. High-value items (regardless of the number of units) are considered more critical to the organization’s financial health and are classified as “A” items.

D. Annual demand:

While annual demand is an important factor in inventory management, it is not the primary basis for ABC analysis. The primary focus of ABC analysis is on the financial impact, which is represented by the annual dollar volume.

High-demand items may or may not have a high annual dollar volume depending on their unit price. ABC analysis provides a more comprehensive picture by considering both the demand and unit price.

In summary, ABC analysis classifies inventory items based on their annual dollar volume, which is a measure of their financial impact on the organization. By categorizing items into “A,” “B,” and “C” classes, businesses can allocate resources and efforts more effectively to manage their inventory.

The other options, such as item quality, unit price, the number of units on hand, and annual demand, are important factors in inventory management, but they are not the primary criteria used in ABC analysis.