In inventory management, many things play an essential role. When it comes to reordering products, the business needs to make sure they are ordering the right amount so that there are not too many and not too few. This is why, to optimize product order, the business uses the Economic Order Quantity/ EOQ formula.
This helps with the calculations and ensures that the optimal order is placed. If you are curious to learn more about this phenomenon and how the EOQ formula can help in business and inventory management, then this article has everything you need to know.
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Part 1. What is Economic Order Quantity
The first question that comes to mind is what Economic Order Quantity/ EOQ is. This is a formula that helps businesses order the correct number of inventory so that they don’t run out of stock while ensuring the warehousing space and cost that they have to pay. With the help of this EOQ formula, the business will be able to meet the demand of the customers without over- or under-ordering the stock.
Hence, this tool is essential in the business as it helps determine the volume and the frequency of the orders so that the business runs smoothly without facing any hurdles.
Part 2. What is the EOQ Formula
The next thing you need to know is how to calculate the Economic Order Quantity/ EOQ. For this, you need a formula, and the EOQ is as follows.
EOQ = √ [ (2 x S x D) / H]
Following are the different components of this formula.
S: Setup costs
D: Demand cost
H: Holding cost. To calculate the holding cost, you need to use the following formula:
Holding Cost = (Storage Costs + Employee Salaries + Opportunity Costs + Depreciation Costs) / Total Value of Annual Inventory.
Once you have added all of these differences, you will be able to find the total Economic Order quantity/ EOQ and order your products according to that number.
Part 3. Economic Order Quantity (EOQ) Example and How to Calculate
EOQ is very important when placing orders for the inventory. Therefore, you must understand the formula and also how it works. Now that you know the EOQ, we have mentioned an example below that will help you understand how to calculate this value.
An optics company has an annual demand of 10,000 units, and the cost of the company is about $5000 for every location. Furthermore, the price per unit of the product is about $3, which means the carrying cost here is about is about 10%.
If we add these values to the formula, then we will have
EOQ = √ [ (2 x 10,000 x $5000) / $3]
EOQ = √ [33,333,333.33]
EOQ = 5,774 units.
This means that according to this value, the company’s economic order quantity is about 5,774 units per order, and these sites will be used twice per year.
We have another example that will help you understand this better. For instance, you are working in a business of scented candles, and your holding cost is about $0.75 per unit with a demand rate of 10,000 units per year. The setup cost is about $500. If you put the values in the formula, then you get:
EOQ = √ [ (2 x 500 x 10,000) / 0.75]
EOQ = √ [ 10,000,000 / 0.75]
EOQ = √ 13,333,333.33
EOQ = 3,652 units per order.
This means that the optimal number to place the order when it comes to restocking is 3,652 units.
Part 4. Why Economic Order Quantity is Important
You might wonder why this EOQ formula is so important and why we need to use it during inventory management. There are many reasons why this Economic Order Quantity/ EOQ forum plays a crucial role. Below, we have mentioned some of the reasons why this formula is so important.
Allows You to Manage Storage
The first and main reason is storage in your inventory. When you order products without checking how much space you have in your inventory and whether you have enough space to keep those products, it can become a huge hassle in no time. This is why calculating beforehand the number of items you need according to the space in your inventory will help you manage everything more effortlessly.
Improves Customer Satisfaction
When you are doing business, the main aim is to ensure that the clients are happy and satisfied. When you order the products after doing the EOQ calculation, you will be able to have the right amount of products without being in stock. This means that whenever a customer places an order, you will be able to ship it immediately and keep your customer happy, improving the customer experience.
Lower Waste
With the help of this formula, you can order the correct amount of products. This means that there will be no overstocking in the inventory and that there will also be fewer cases of dead stock. Therefore, make sure you calculate your inventory before ordering to avoid product wastage.
Quantity Discounts
When it comes to ordering and knowing the right amount of stock you need to purchase, you can easily avail yourself of discounts and the best bulk orders. Timing your purchase during the season of discounts will help you gain more profit.
Part 5. How to use the EOQ Formula in Your Business
If you are a business owner and you are wondering how to use the EOQ formula, then the things that you must know are below.
Gather the Data
After learning about the EOQ, the first and most important thing is collecting the correct data. For the formula to work correctly, you need to know the demand rate, which is how much product you need to get per year. You can gather this information by going into your records and checking the history of the orders.
Other than this, you need to know the setup costs, which are also referred to as the order costs. This means you need to know how much the order costs you and the amount you need to pay for the shipping and handling of the products. Lastly, the holding cost is the total cost that you need to spend on holding and storing the products in your inventory.
Calculate the Economic Order Quantity/ EOQ
Now that you have all the values, you need to calculate the EOQ. You can start adding all the values in the formula and then calculate it. The final value that you will get will be the units that you need to order every time you are short on the products.
Check Other Factors
After having the Economic Order Quantity/ EOQ, you also need to check other factors. This means that you need to look into your inventory, the space that you have, the purchase cost, and similar things. This will ensure that you are making the right decision according to your business’s conditions.
Place the Order
The last thing you need to do after checking the inventory and all the other factors is place the order. Make sure to ask for discounts and packages as you will be placing a bulk order. This will help you save money and get your products for a lower amount.
By using this entire method, you can ensure that your business runs smoothly. You will be able to have enough items in your inventory to ensure that customers get their orders right in time. However, it also ensures that you are getting only a few extra products that will go to waste and cause a loss of your business.
Conclusion
Economic Order, Quantity/ EOQ, is an essential formula that is used by businesses all over the world. With the help of this, the companies are able to understand the number of items that they order with over or under-stocking their inventory. Other than this, there are many other benefits as well, such as reducing waste, being a cost-effective way of ordering products, and so much more. Hence, this article was beneficial for you and now you know what EOQ is and how it can benefit your business. Also, make sure to check out NextSmartShip if you want to enhance your inventory management and also get better shipping rates.
