The economic order quantity (EOQ) refers to the ideal order quantity a company should purchase in order to minimize its inventory costs
it refers to the number of units you should add to inventory with each purchase order
Too much of Inventory which has no sale can increase storage costs and reduces available cash flow
It lowers holding costs, and avoid stockouts.
It helps ideal order quantity to maximize inventory
KEY TAKE AWAYS
The economic order quantity (EOQ) refers to the ideal
order quantity a company should purchase in order to minimize
its inventory costs.
A company's inventory costs may include holding
costs, shortage costs, and order costs.
The economic order quantity model seeks to ensure that
the right amount of inventory is ordered per batch.
This is so a company does not have to make orders too
frequently and there is not an excess of inventory sitting on hand.
EOQ is necessarily used in inventory management, which is
the oversight of the ordering, storing, and use of a company's inventory.
EOQ FORMULA :
S=Setup costs (per order, generally including
D=Demand rate (quantity sold per year)
Suppose that Mr.X deals in bicycles and has an annual sale of 6000 units.
The ordering cost per order is US$ 300, and per unit of the bicycle holding cost is $50.
His Economic order quantity calculation will be
as below:
EOQ=
Square root of (2x 6000x 300/ 50)
Square root of 72000
Mr.X EOQ is 268 units of bicycles, where
he will minimize the risk of running into a shortage of stock and keep control
of his holding cost as well.
Let
us take three different scenarios to get to point.
Case 1: Mr.X decides to
order in lots of 200 bicycles
Total
number of orders per year: 6000 units /200= 30 orders
Total
ordering cost per year= 30 x 300= US$ 9000
Annual
holding cost= 200/2 x 50= US$ 5000
His
Annual Total Cost= US$ 9000+ US$5000= US$14000.
Case 2: Mr.X decides
to order in lots of 300 bicycles
Thus,
the total number of orders per year: is 6000 units /300= 20 orders.
Total
ordering cost per year= 20 x 300= US$ 6000
Annual
holding cost= 300/2 x 50= US$ 7500
His
Annual Total Cost= US$ 6000+ US$7500= US$13500.
Case 3: Mr.X decides
to order in lots of 268 bicycles
Thus,
the total number of orders per year: 6000 units /268= 22.39 orders.
Total
ordering cost per year= 22.39 x 300= US$ 6717
Annual
holding cost= 268/2 x 50= US$ 6700
His
Annual Total Cost= US$ 6717+ US$6700= US$13417.
Therefore,
we can see that his annual total cost is minimum in case 3,
How to Use Economic Order Quantity:
To calculate the EOQ for inventory you
must know the setup costs, demand rate, and holding costs.
Setup costs refer to all of the costs
associated with actually ordering the inventory, such as the costs of
packaging, delivery, shipping, and handling. Demand rate is the amount of
inventory a company sells each year.
Holding costs refer to all the costs
associated with holding additional inventory on hand. Those costs include
warehousing and logistical costs, insurance costs, material handling costs, inventory write-offs, and depreciation.
Ordering a large amount of inventory
increases a company's holding costs while ordering smaller amounts of inventory
more frequently increases a company's setup costs. The EOQ model finds the
quantity that minimizes both types of costs
TOTAL INVENTORY COSTS
- Holding costs:
1.
It is storing
inventory that remain unsold
2.
It is part of
total inventory cost
3.
It is additional
inventory is in the store
4. It also includes (Price
of goods damaged / spoiled, storage space, labour, Insurance, Logistics)
Ø To avoid the holding cost, calculate the re order
points
Ø Holding costs reduction methods: selling inventory to
the customers and collect the money
Ø Note:
Holding large amount of inventory that leads to more holding costs
• Setup costs:
1.
Costs which are
associated with ordering the inventory
2. It includes the cost of packaging, delivering, shipping and handling
EOQ considers the timing of reordering, the cost incurred to place an order, and the costs to store merchandise. If a company is constantly placing small orders to maintain a specific inventory level, the ordering costs are higher, along with the need for additional storage space.
WHAT ARE THE ADVANTAGES WITH EOQ?
• It helps
purchasers answer two critical questions for optimizing stock levels:
1.
How much to order?
2.
When to order?
• It helps retailers
minimize the total costs of inventory.
• It is number of units / stock a business should add to its Inventory
• It enables the business unit to order right amount of inventory per batch
• with this Implementation we can hold stock which are having more demand
• it helps us to cannot order frequently so that there we will be no excess inventory with us
• EOQ also helps us in below aspects
1.
How much inventory to keep on hand
2.
How many items to order each time
3.
How often to reorder to keep costs low?
Note : Above data example taken from internet for knowledge delivery and understanding purpose to my blog viewers, if content owner had any objection with using his data can contact to mail id : prasanthsrinu0@gmail.com
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