Why Do We Need To Know About Economic Order Quantity?

Big companies would probably need a collection of Techniques, Tools and Strategies for the process of storage, track, deliver and order an inventory or stock to minimize the losses and maximize the profits where the giant technique called Inventory Management plays come into play. The Economic Order Quantity (EOQ), first among the sub-techniques of Inventory takes it way below.

 Economic Order Quantity (EOQ)

The Economic Order Quantity (EOQ) simply means a set of calculations that allows an business to calculate the exact time and quantity an order needs to be placed that allows it to continue the normal production and minimize the inventory cost.

        Economic Order Quantity = Sq. Root [(2SD) / (PI)]

S => Cost to place the order

D => Demand for the goods

P => Production cost

I => Opportunity cost of holding the goods

Here, the carrying cost is associated with warehouse and security costs and the ordering cost is associated with personnel and shipping cost, both being interrelated at an instance. The ordering cost of the inventory lowers with higher quantity and less shipments but increase the carrying cost since more inventory sits on selves longer. The ordering cost of the inventory increases with lower quantity and high shipments.

What does EOQ briefs?

The Economic Order Quantity (EOQ) is considered as the largest asset owned by a company or business, carrying sufficient inventory to meet the customer needs. The other main involvement of EOQ is the reorder point, calculated to trigger the need to place an order for more units.

A shortage in cost rises when a company runs out of inventory and fails to fill an order thus leading to loss of customer in the future. This can be reduced to a greater extent and the customer needs can be filled by determining the reorder point.

 Advantages of EOQ

EOQ reduces holding cost

It greatly decreases the need of wanting a big warehouse space since the company can order goods in limited quantity that the current production of the goods does not come to a halt condition. In simple words, lacking of EOQ forces a company to spend more on purchasing a warehouse or taking a warehouse on rent.

Reduced ordering cost

There lies a big difference between ordering 10 goods a month and paying those 10 times and ordering 1 good per month and paying once. EOQ helps ordering goods on fixed date that helps reduce the ordering cost.

Disadvantages of EOQ

Accurate demand forecasting not possible

Moving on practically, no product or goods remain static rather it keeps on changing depending on the company’s product demand. Hence, this system works based on assumption.

Difficulty with immediate availability of products

The probability that the suppliers may or may not have the raw materials at specific time to meet the unexpected demand of the company plays a major role in the disadvantages of EOQ. EOQ needs continuous monitoring of the goods.

Summary

EOQ is a calculation of specific amount of products or goods to be purchased at an instance that can greatly reduce the annual carrying and ordering cost of the items in inventory.


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