Economic Order Quantity

What is EOQ?

Economic Order Quantity, also known as EOQ, is a widely used inventory management technique that helps organizations determine the optimal level of order quantity for a particular item, which minimizes the total inventory costs. The primary goal of EOQ is to provide a balance between the costs associated with ordering and holding inventory efficiently.

What are the factors impacting EOQ?

• Units consumed during the year (A): The organization has to determine the annual demand for the product. This is the quantity of the product that your business expects to use or sell in a year.
• Ordering Costs (O): The organization has to determine and calculate the cost incurred each time an order is placed. This includes administrative costs, transportation costs, and other expenses related to the procurement process.
• Holding Costs or Carrying Cost (C): The organization has to determine the annual holding cost per unit of inventory. This includes all incidental costs like warehousing, insurance, security, and the opportunity cost of tying up capital in inventory.
• Unit Cost: Know the cost of each unit of inventory.

How does lead time affect EOQ?

EOQ itself does not directly account for lead time, but businesses must ensure they reorder when inventory levels reach the reorder point, calculated considering lead time to prevent stockouts.

Can EOQ be used for multiple products?

EOQ is typically calculated for individual products. For multiple products, adjustments or different inventory management techniques may be required.

How does EOQ handle variable demand?

EOQ is based on the assumption of constant demand. For variable demand, more sophisticated models like dynamic lot-sizing or safety stock adjustments are necessary.

What is the reorder point in EOQ?

The reorder point is the inventory level at which a new order should be placed. It is calculated as:

Reorder Point = Lead Time Demand

where Lead Time Demand is the demand during the lead time.

Can EOQ be applied to all types of businesses?

EOQ is widely applicable but may not be suitable for businesses with highly variable demand, short product life cycles, or complex supply chains. In such cases, alternative inventory management methods may be more effective.

How does EOQ relate to Just-In-Time (JIT) inventory?

EOQ focuses on balancing ordering and holding costs, while JIT aims to minimize inventory levels by receiving goods only as they are needed. Both seek to optimize inventory but with different approaches and priorities.

Give two uses of EOQ.

• Improved Order Fulfillment: When a business is in need of a certain item or inventory to procure an order, an optimal level of EOQ ensures the product is on hand, which in turn helps the organization get the order out on time and cater to customer needs. This helps to enrich the customer experience and lead to increased sales.
• Less Overordering: An accurate forecast of what an organization needs and when it will need it helps to avoid overordering and tying up too much working capital in inventory.