Wrestling with how much to order? Wondering when you should order material? Often times, managing inventory via an Economic Order Quantity or EOQ can be a very effective technique. But what is it and how can that ideal ordering point be determined? What follows is a bit of a primer on EOQ’s.
By definition, Economic Order Quantity is a formula used to calculate inventory stocking levels. It’s main purpose is to help a company maintain a consistent inventory level and to reduce costs. EOQ uses variables annual usage amount, order cost and warehouse carrying cost. Companies can use the EOQ equation to effectively determine the most cost-effective number of goods to order in correlation to operating costs of the business.
EOQ = 2 *Annual Demand (Usage) * Order Cost / Carrying Cost
Essentially, the method tries to balance the goal of ensuring that there is inventory to satisfy demand while considering the ordering and carrying costs; trying to keep those as low as is possible.
Why is it needed? Well, inventory is expensive. It’s expense to manufacture or procure and it’s expensive to keep in stock. Whether it is raw materials, Work in Process (WIP) or Finished Goods, companies can use Economic Order Quantity as an efficient ordering guideline to prevent shortages while not maintaining excess inventories. Economic Order Quantity is often one of many inventory planning techniques available in an inventory control or ERP solution. Other techniques include Reorder Points, Period of Supply, etc.
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