The economic order quantity (EOQ) in inventory management is used to handle a company’s inventory more wisely, which can reduce total inventory costs with each batch order. The EOQ model in inventory management makes sure the correct inventory quantity is available so that the customers receive their orders on time and trust the company as a brand.
Knowing the importance of EOQ in inventory management strategies, companies can expand their business exponentially. In this article, you will learn more about economic order value and how it helps companies to grow and improve.
What Is an EOQ Model?
The EOQ or economic order quantity model is the ideal quantity of products a company buys to reduce its inventory costs. These inventory costs include holding, shortage, and order costs. These costs help to minimize expenditures and manage economic goals better. It allows companies to reorder at times only when orders are sold so that they can manage their inventory better.
The EOQ model is the perfect tool to forecast demands and set up reorder points at intervals, reducing sitting inventory. EOQ calculates the time of reordering, the cost at which the company places an order, and the costs to store goods.
Factors that Affect Economic Order Quantity
Here are the 8 main factors that affect economic order quantity for a company:
1. Reorder Point
It is when you need to reorder another set of stock or upgrade the existing stock. The EOQ model assumes you order the same quantity at each reorder point.
2. Purchase Order Lead Time
It is the period from placing the order until the order is delivered. EOQ assumes that the lead time is constant.
3. Purchasing Cost Per Unit
The cost per unit never changes over the period, even though the order quantity is adjusted. EOQ always considers that you pay the same price per product every time.
4. Stockouts
You always have to carry enough inventory to avoid stockout costs. It clearly says that you always have to observe your customer demand, along with your inventory levels, carefully.
5. Quality costs
The quality cost is the cost that explains the value of goods in terms of money. EOQ analysis in inventory management never focuses on the quality costs but rather the carrying costs.
6. Demand
It’s about how much the customer wants the product for a specific period. The EOQ is based on the demand rate, which tells how much a company sells annually.
7. Relevant Ordering Cost
The cost per purchase order is called the relevant ordering cost.
8. Relevant Carrying Cost
The cost involved in the entire maintenance and carrying of the stock for the specific period is called the relevant carrying cost.
Advantages of using the EOQ model in Inventory Management
There are several advantages of using Economic Order Quantity (EOQ) in inventory management which include:
1. Reduces Total Inventory Costs
The EOQ model can help businesses reduce inventory costs by finding the optimal order quantity. Companies can also reduce costs related to ordering inventory and holding it.
2. Improves Customer Service
With the EOQ model, the company can make sure sufficient inventory to fulfil market demands. Product availability provides better customer service and satisfaction, resulting in higher sales.
3. Easy to Use
The EOQ model is easy to use and a simple approach to inventory management. This tool is straightforward and can quickly calculate the optimal order quantity.
4. A mix of other Techniques
EOQ can be used as an added tool as well. This tool can be blended with safety stock, reorder points, and just-in-time inventory systems to provide a better inventory management approach.
5. Improve Forecasting
EOQ is a tool that can help businesses determine optimal order quantity, improving demand forecasting and understanding the market needs better.
6. Setting Inventory Levels
The EOQ model helps set inventory levels. This tool guides companies so that the inventories are neither too high nor too low, reducing the carrying and ordering costs.
7. Determining the Reorder Point
With optimal order quantity, companies can use EOQ models to find the ideal time for reorder points. It will help them to manage inventory better.
Disadvantages of Using the EOQ Model in Inventory Management
Here are a few disadvantages of Economic Order Quantity (EOQ) in inventory management:
1. Assumes Constant Demand
The EOQ model assumes that the demand is constant, which might not be accurate for some industries. If there is no continuous demand, the result is not optimal for the exact order quantity.
2. Neglects Lead Time
The EOQ model also assumes that there is no or negligible lead time. This also might result in further inaccuracies in calculations.
3. Constant Costs
The model assumes that the ordering and carrying costs are constant, which might be false for some companies. It can result in inaccurate optimal order quantity value.
4. No Stockout Cost
The EOQ model is a tool that does not consider the cost of stockouts. In the real world, companies must consider a scenario where they might face stockouts and be equipped with solutions to resolve such issues.
5. Only One Item
The EOQ model is applicable for one item and unsuitable for companies dealing with multiple products.
6. Simplistic
EOQ is relatively simple and does not consider the complexities of the real world. With the actual world application of EOQ in inventory management strategies, companies can avoid demand uncertainty, multiple suppliers, and guessed lead times.
Example of How to Use EOQ in Inventory
Consider a company that manufactures electrical sockets.
- Approximately 1000 electrical sockets are sold each year at the shop.
- The company pays 5 rupees per piece to keep these sockets in inventory.
- This cost is called the holding cost. Electrical sockets are fixed at 2 rupees each.
Using the formula of eoq in inventory management, the square root of annual demand multiplied by order cost per purchase order will give the ideal order quantity.
Therefore according to the formula square root of ( 2 x 1000 x 2Rs. order cost) / (5Rs) holding cost, the ideal order quantity comes to around 28.3 after rounding up. That means the proper order quantity is more than 28 electrical sockets.
Use EOQ For Maximum Growth With TranZact
Economic order quantity might not consider all factors that affect business, but it is a powerful tool to reduce inventory costs and manage business demand. With TranZact’s inventory and manufacturing software, you can find the optimal order quantity for your company and increase your profits exponentially.
With practical strategies and business management, we can help you grow your business with correct demand forecasting and business opportunities.
Still, wondering about any other related topic to the EOQ model? Comment down below and let us know about your queries.
FAQ
Q1. How do you calculate EOQ in inventory?
The formula for calculating EOQ in inventory management, which determines the optimal order quantity, is EOQ = square root of [2(setup costs)(demand rate)] / holding expenses.
Q2. What are the benefits of EOQ?
The EOQ model has multiple benefits which include:
- Helps companies to reduce storage and other inventory costs.
- Helps to determine reorder points
- Manages inventory as per market demands.
Q3. What are the two objectives of EOQ?
The two primary objectives of EOQ are:
- to minimize inventory costs and
- to calculate market demand with accurate forecasting.
Q4. What is EOQ in inventory management?
EOQ, or economic order quantity, is the calculation to determine the ideal order size for a company. It helps companies to cut costs and storage space.
