Economic order quantity or EOQ is a formula that states how much product should be ordered to meet demand. The manufacturing companies and small businesses face the problem of ordering more or sometimes less than required amount, which raised the cost of holding product or sometimes create stock-outs.
In order to avoid such problems organization by following the best practices and using the EOQ varying depending on the industry.
In this article, we’ll talk about what economic order quantity is, why it’s important, and how to find the right amount.
What is Economic Order Quantity (EOQ)?
Economic order quantity (EOQ) is a manufacturing term that refers to the number of units produced or purchased in a given time period. It can be helpful when assessing production capacity and making decisions about production levels.
In 1913, Ford W. Harris developed the economic order quantity (EOQ) production-scheduling model, which has been improved by R.H.Wilson and K.Andler. It is based on a rule of three:
(1) orders are received by the company and are stored for later processing,
(2) the inventory of product is gradually sold to customers, and
(3) the remaining unsold products are stored in order to be sent out to the next customer.
In almost all cases, EOQ is achieved through the use of manufacturing protocols and standard operating procedures (SOPs). These guidelines provide employees with clear instructions on how to produce products consistently and efficiently. When followed correctly, EOQ can lead to significant cost savings and improved product quality.
This model has been used successfully by many companies, including General Electric, Medtronic, Xerox Corporation’s Document Systems Division, and BASF.
While EOQ is not always easy to calculate, understanding its implications can help you make smart choices when it comes to business operations. So it is necessary to learn more about this important manufacturing term!
Why Should You Care?
Economic order quantity (EOQ) is a manufacturing term that refers to the optimal amount of products to produce in a given time frame. In other words, it’s a way to optimize production while minimizing costs.
EOQ is important for several reasons. Few are mentioned below:
- EOQ is important because it can help manufacturers maintain consistent quality levels and avoid stock overages.
- It can also help to control inventory costs, which can ultimately improve company bottom lines.
- it can help to save on costs by reducing the amount of waste that occurs during production.
- it can improve worker morale by ensuring that they have a sense of responsibility for producing an ordered quantity of products.
- It helps optimize production by ensuring that resources are being used in the most efficient way possible.
- It helps avoid overproduction and inventory build-up, which can lead to lower profits and lower stock prices.
If you’re interested in EOQ for your business, there are a few things you should know. First, it’s important to understand what affects EOQ and how it works. Next, you need to know how to calculate EOQ and apply it to your manufacturing processes. And finally, you need to make sure that your inventory is maintained at an appropriate level so as not to impact your company’s bottom line.
How to calculate Economic Order Quantity (EOQ)?
The economics of running a business are based on the principle that the most cost-effective way to fulfill an order is to buy in bulk. However, sometimes getting the orders in bulk create wastage as well increase the holding cost of the stock because demand fluctuates due to seasonal demand and sudden fall in the customer demand for the product.
If your company is using the e-commerce store, at least you can see how many products are ordered and how much they cost.
EOQ allows you to calculate this number profitably. Here, we have measured EOQ and offer advice on how to calculate it for better flow of stock, minimize storage cost and avoid stock-outs. Note that in order to calculate the Economic Order Quantity (EOQ), you will need variables such as: demand rate, setup costs, and holding costs.
The formula is: Economic Order Quantity (EOQ) = square root of: [2DS] / H.
D= Demand in Units (Per Year)
S= Setup Cost or Order Cost (Per Order)
H= Holding Costs Per Unit (Per Year)
Let’s say you have following variables:
D= 20,000 units /year
S= Rs 3,000 /order
H= Rs 125 per unit /year
The we will use the following formula:
Square root of [(2)(20,000)(3,000)/125] = 979.79 units, which equals the approx order quantity of 980 units for that specific product.
By understanding how many units of a particular product can be produced at any given time, organization can make better decisions about how to allocate resources and achieve your production goals. Knowing the right number can help you manage the resources more effectively and save money.
Benefits of Economic Order Quantity (EOQ)
Economic order quantity (EOQ) is a manufacturing process that helps to improve efficiency and reduce costs. It involves coordinating the production of multiple products by specifying how many items should be produced at any given time. By doing this, manufacturers can minimize waste and ensure that products are delivered on time. Additionally, EOQ can help to improve customer service by ensuring that products are available in sufficient quantities.
There are several benefits to using EOQ in manufacturing. Few are mentioned below:
- First, it allows for better coordination between workers and machines. This leads to increased efficiency and less wasted time and materials.
- In addition, EOQ can help to improve quality by ensuring that products are produced at the right temperature and in the correct quantity.
- Finally, EOQ can help to reduce costs by reducing the number of orders that need to be processed. Overall, EOQ is a valuable tool that can help companies save money and improve their overall performance.
Drawbacks of Economic Order Quantity (EOQ)
When businesses use economic order quantity, they are essentially striving for a certain level of output. This is often done in order to keep costs low and maintain a competitive edge. However, there are some drawbacks to this approach.
Disadvantages of Economic Order Quantity (EOQ):
- Using Economic Order Quantity means that there is a set amount of inventory with each product. As this inventory gets used up, there is more risk that customers who want to purchase the items will not be able to get them.
- Also, when it comes to ordering the products, given all of the planning that goes into it in advance, you may potentially spend more money per customer than you would if you were to use traditional marketing.
- In the event that you run out of inventory, then you will likely have to put a hold on orders until more can be ordered.
- Any analytical data that is available to predict how much inventory should be ordered is limited.
Economics is the study of how people use scarce resources to meet their needs and desires. In business, this can mean understanding what economic order quantity (EOQ) is, why it matters, and how you can apply it in your own work. EOQ is a manufacturing process that helps manufacturers produce products at the right scale for efficiency and profitability.
By understanding EOQ, you can make informed decisions about when and how to produce products, saving yourself time and money on both the front end and back end of your business.