Economic Order Quantity Technique
The Economic Order Quantity (EOQ) is the ideal number of units to purchase to meet demand while minimizing inventory costs, such as holding costs, shortage costs, and order costs. Ford W developed this production-scheduling concept back in 1913. Harris and has subsequently been enhanced. Constants for demand, ordering, and holding costs are included in the economic order quantity computation.
EOQ = Square Root Of: [2(Setup Costs)(Demand rate)] / Holding costs.
Q = EOQ units
D = Demand Rate
S = Order Cost
H = Holding costs
The EOQ formula aims to determine the optimal quantity of product units to order, enabling companies to minimize the costs associated with purchasing, shipping, and storing items. Large businesses with complex supply chains and fluctuating costs use computer software algorithms to calculate EOQ. By modifying the EOQ formula, organizations can determine optimal production levels or order intervals.
Improved profitability is the key advantage of EOQ. The following advantages all add up to savings and enhancements for your company:
- Improved Order Fulfillment: Optimal EOQ guarantees that the product is on hand when you need it or when something is needed for a client order, enabling you to ship the order promptly and keep the customer satisfied. This should raise customer satisfaction and may increase income.
- Less Overordering: You may prevent over-ordering and locking up too much cash in inventory by making an accurate prediction of what you need and when.
- Less Waste:More efficient order schedules should lower outmoded inventory, particularly for businesses that keep perishable commodities that could result in dead stock.
- Lower Storage Costs: There should be fewer products to store when your ordering is in line with your demand. This could lead to lower costs for utilities, real estate, safety, insurance, and associated costs.
- Quantity Discounts: You can take advantage of the finest quantity or bulk purchase discounts provided by your vendors by strategically planning and scheduling your orders.
The EOQ formula takes the idea of steady customer demand for granted. Furthermore, it is assumed that the computation takes into account that the ordering and holding costs remain constant. Because of this, the formula has a difficult or impossible time taking into account business events like shifting consumer demand, seasonal variations in inventory costs, lost sales due to inventory shortages, or purchase discounts an organization might experience when purchasing inventory in larger quantities.
The amount of inventory a business should order to meet demand while lowering total ordering, receiving, and holding costs is known as the economic order quantity (EOQ).
The EOQ formula is most suitable for situations where the demand, ordering, and holding costs are constant.
However, one major limitation of the economic order quantity is that it assumes a constant demand for the company's products over time.