Economic Order Quantity
Businesses that carry large or high-end inventory items may find working with an economic order quantity (EOQ) beneficial.
What is EOQ?
The economic order quantity for inventory management is the least amount of inventory the business can carry while continuing to meet demand. Keeping inventory levels low lends itself well to just-in-time inventory business models, a strategy of producing product only when an order is received.
Initially used by Ford back in 1913, this approach allowed the automaker to reduce the amount of storage required for finished product while limiting cash flow tied up in raw materials. Cars are sold with options and upgrades; when the order is received with these specifications, the car can be finished to meet the customer’s preferences. The outcome is more flexibility to produce exactly what the consumer will purchase.
The Economic Order Quantity Formula
When using the economic order quantity formula, you assume that demand, purchase orders and storage costs stay the same. Calculations are often performed on a yearly basis.
To calculate EOQ, you will first multiply demand over the course of a year by the average acquisition cost per product and then multiply that number by two. Divide that product by the holding (storage) costs for one full year. The square root of that product gives you your EOQ quantity. The EOQ quantity is the amount you will order each time your quantities drop to the minimum order point.
An Economic Order Quantity Example
If the cost of materials to create one hat is $1.50, you sell 2,000 hats each year and the holding cost is $2, your EOQ formula would look like this:
This gives you an EOQ quantity of 58 when rounded off.
The economic order quantity model is not ideal for industries whose products fluctuate greatly in demand such as seasonal items. When working with bare minimum quantities, predictability is a must for the process to be effective for your business. The alternative scenario entails facing shortages, loss of sales and production stoppages.
When you manage your inventory with SOS Inventory software, the appropriate calculation for your inventory method is automatically determined. You can automate purchase orders of raw materials whenever minimum thresholds (your predetermined reorder points) are met to insure you are always meeting demand with consistent quality while minimizing your inventory costs as much as possible. By managing your inventory with SOS Inventory software, your staff can save time and ensure raw materials are always replenished at the appropriate time to meet demand while safeguarding your profits.
Working with an economic order quantity is a just one small piece of the inventory puzzle that contributes to greater efficiency. SOS Inventory was designed with small businesses in mind to help them streamline workflow processes, track quantities and costs, and reduce waste. If your goal is to limit inventory expenses so you can focus cash flow towards other areas of your business, you need a tool designed to trim the fat and provide greater transparency. Start your free trial today for a more profitable journey for years to come.