Economic Order Quantity

Economic order quantity (EOQ) is a computation that businesses use to determine their ideal order size, which allows them to meet demand without going over budget. Inventory managers calculate EOQ to reduce holding costs and surplus inventory. The Economic Order Quantity is used to help businesses reduce the cost of purchasing and storing inventory. Because of purchasing economies of scale, the cost of ordering goods decreases as the order volume increases. However, when inventory grows in size, the cost of keeping it in stock increases. EOQ is the exact moment when both inversely associated expenses are minimised.

Importance of Economic Order Quantity (EOQ)?

Ordering too much can result in excessive holding costs and divert resources away from other business operations, such as marketing or R&D, that could help your company grow sales or cut costs.

Working capital includes inventory. Working capital refers to the assets that a company needs to run its day-to-day operations. However, having too much working capital can cut your profits and constitute a significant opportunity cost.

EOQ may not be very useful when it comes to organising your office supply cupboard. It’s especially crucial when making large, high-volume, or pricey transactions. Economic order quantity has a higher impact on earnings as your orders and inventory expand and scale.

Calculating Economic Order Quantity (EOQ)

Calculating the economic order quantity necessitates advanced algebra. It’s simple to punch in the figures and calculate EOQ after having the variables from your inventory management system. These computations and order costs, such as inventory ordering costs, holding charges, and stockout costs, may be handled for you if you utilise a robust ERP.

The EOQ is calculated using three variables (or inputs).

The formula for calculating EOQ can be found in several different forms. These variables, commonly known as inputs, are used in one typical Economic order quantity formula:

D stands for demand in units (annual)

S stands for “order cost.”

H stands for holding costs (per unit, per year)

Economic Order Quantity (EOQ) Formula

EOQ is equal to √ [2DS/H]

Example of EOQ 

Here are economic order quantity examples that would help you understand the working of economic order quantity. Let’s imagine a company using its ERP platform efficiently to forecast demand, order cost, and holding expenses per unit and year over the previous year and forecast comparable demand for the coming year.

Last year’s demand was ten thousand units. The average cost of each order was $5,000. The annual holding fee is $3 per unit.

EOQ = √ [2 x D x S / H]

= √ [ (2 x 10,000 x $5,000) / $3]

= √ [33,333,333.33]

= 5,774 units

Benefits of Utilising Economic Order Quantity

The key advantage of employing EOQ is increased profitability. Here’s a list of advantages that add up to significant savings and improvements for a company:

Improved Order Processing

When a certain item or anything is required for a customer order, optimal economic order quantity ensures that the product is available, allowing you to complete the order on schedule and satisfy the customer. This should enhance the consumer experience and possibly increase sales.

Less Waste

Better order scheduling should reduce outmoded inventory, which is especially important for organisations with perishable supplies that can lead to dead stock.

Storage Costs are Reduced

You should have fewer things to store when your ordering meets your demand. This can help save money on real estate, utilities, security, insurance, and other expenses.

Quantity Discounts

By properly planning and timing your orders, you may take advantage of your vendors’ best bulk order or quantity discounts.

How to Use EOQ to Improve Inventory Management?

When you compute economic order quantity, you can figure out what order size is best for your company to optimise earnings. It eliminates guesswork, and there’s less risk of over-ordering or running out of stock. You may use the data and stats to make the greatest long-term inventory selection for your company.

Suppose you manage a large company that requires expensive inventory or has high inventory holding costs. In that case, EOQ could have a big influence on your bottom line, enhancing operational efficiency, cash flow, and profits for years.

Conclusion

You may optimise your overall inventory management process by adopting an economic order quantity formula for your e-commerce firm. You can save money, avoid stockouts, and keep your supply chain running smoothly by ordering the exact amount of goods instead of guessing. Economic order quantity may not consider all of the elements that affect a company, but it can still be a useful tool if it fits your needs.