Inventory management is essential for every product-based firm, but it can be a sensitive process for businesses of all sizes. Because carrying inventory is inherently costly, eCommerce businesses must be highly cautious about the number of orders they place and how they load their warehouses.
When it comes to inventory management, certain things will need to be reduced, while others will almost certainly require reordering (to avoid lost sales). This ebb and flow can be challenging to deal with, but it's one that economic order quantity is prepared to take on.
What Is Economic Order Quantity?
Economic Order Quantity formula that determines how many units your company should add to its inventory order. This inquiry is about lowering total inventory management expenses, which include things like order costs, holding costs, and shortage costs.
You'll need your annual demand, fixed costs, and annual carrying cost per unit to utilize our EOQ algorithm. Your fixed expenses are the money you spend on stock, approvals, and inspections, while your carrying costs are the money you spend on things like storage and utilities. So if your company is up and running, all you have to do is go through your records to see how much you spent on stock and how much demand was last year.
In most inventory management workflows, the EOQ is used to set the reorder point. These data, when combined, inform you when to place an order (reorder point) and how much to order (Economic Order quantity formula). This keeps you from having too much deadstock on hand or having to deal with stockouts.
How To Calculate EOQ (Economic Order Quantity)
Economic Order Quantity Formula:
EOQ = √((2 x Demand x Ordering Cost) ÷ Carrying Costs)
Using the formula mentioned above, you can calculate the EOQ. Now let's discuss the factors on which an EOQ depends.
Factors To Accurately Calculate EOQ
Economic order quantity has a few parameters that must be computed, albeit it is not unduly hard. The EOQ calculation must account for annual demand, holding costs, and order costs for each purchase to produce the most accurate results.
Demand On An Annual Basis
The word 'annual demand' refers to the demand for a specific product that your organization receives each year. You can look into a variety of historical data, such as turnover ratios, reorder points, and even purchase orders, to verify the demand rate for your own business. With these details in hand, you'll have a fair notion of how many units you're selling year over year, which will help you figure out your EOQ (and support their accuracy, as well).
Annual holding costs might be direct expenditures associated with storing your inventory or opportunity costs associated with keeping a list rather than investing that money elsewhere. You'll need to know how much you spend on maintaining inventory units every year before you can calculate your EOQ. To calculate your holding costs, add storage fees, personnel wages, opportunity costs, and depreciation expenses together, then divide by the total worth of your annual inventory.
The Cost Of Your Order
Order costs are incurred to create and process an order with a supplier, such as preparing a purchase order or inspecting goods after they've been received. More broadly, order costs are all the expenses incurred to create and process an order with a supplier, such as preparing a purchase order or inspecting goods after they've been received. Because they contribute to total inventory costs and influence various crucial components of order fulfillment, these costs play a significant role in establishing the item's economic order quantity.
Ways Of Calculating Economic Order Quantity (EOQ)
Economic order quantity, when used effectively, can reduce the cost of purchasing and storing inventory, allowing your organization to save as much money as feasible. Using the economic order quantity formula, an EOQ calculator, or adding EOQ metrics in your inventory management are all options for calculating your EOQ.
Using The EOQ Equation, Manually Calculate EOQ
You can use an economic order quantity formula to compute the order quantity, ensuring that the combination of ordering and carrying expenses is kept to a minimum (which lowers your cumulative inventory costs). Follow the formula to compute EOQ manually cost:
EOQ = [2DO] / H square root
D stands for demand, O for order expenses, and H for holding costs. However, keep in mind that this calculation does not take into account interest or opportunity fees. These can be calculated by multiplying your holding expenses by the current risk-free rate in the denominator of the equation.
For Rapid Calculations, Use An EOQ Calculator.
If you don't like doing math by hand, you can use an economic order quantity calculator to calculate your EOQ for you. Of course, you'll still need to enter your annual demand, order expenses, and holding costs into these online calculators, but they'll do the math for you.
Include The EOQ Excel Calculator In Your Management Process
Another option for EOQ calculations is to incorporate them into your current inventory management system. By combining the EOQ method with your current inventory techniques, you'll undoubtedly find some cash savings that you may use toward other investments.
Benefits Of Using EOQ Formula Calculator
At its most basic level, cost efficiency is all about saving money, which any company in any industry can agree. However, to save money and increase revenues, your organization may need to make a few changes (or additions) along the road. For example, your brand can not only cut total inventory expenses but also enhance inventory forecasting and avoid stockouts by adopting EOQ into your operational plan.
Increase The Accuracy Of Inventory Forecasting
There's a significant likelihood that a company's profitability will suffer if it has too much or too little inventory on hand. For example, if you have excess inventory in your warehouse, it can influence your inventory turnover ratio and cause financial problems. On the other hand, if you don't have enough stock to meet all of your orders, on the other hand, you risk losing sales and disappointing customers. Fortunately, calculating EOQ improves demand forecasting accuracy, making it easier to keep proper inventory levels at all times.
Inventory Expenses Are Reduced
Carrying, holding, and storage expenses are all terms used to describe inventory costs for eCommerce retailers. They all rise in direct proportion to the amount of inventory you have on hand. To put it another way, having too much stock in your warehouse might have a significant impact on your bottom line (as you'll still have to pay unit charges on unsold items). However, you may avoid having an excess of stagnant goods by leveraging your company's unique EOQ and instead store the proper volume of SKUs to fulfill consumer demand effectively.
In general, inventory shortages are blamed on an unexpected rise in demand, although stockouts can also be caused by poor forecasting and inaccurate reporting. Your organization can better understand how much (and how often) to restock by prioritizing EOQ, so stockouts are no longer a threat to your supply chain. This is because economic order quantity gives you more visibility into your previous, current, and potential stock counts, which can help you figure out what product quantities are the most cost-effective to have on your shelves.
Related: How To Calculate Safety Stock For Your Business in 3 Easy Methods
Cautions While Using The EOQ Formula
The EOQ is predicated on the premise that demand would remain constant and that ordering and carrying costs will remain constant. These assumptions, however, do not hold in the real world. According to the changes in the economic life cycle, demand continues to fluctuate. It also implies that no discounts are available when purchasing large amounts, which is incorrect.
The biggest and most serious flaw is that it completely ignores price fluctuations in the materials. Even if there is a modest increase in the price of materials during the year, you may significantly outweigh all savings. As a result, management must make judgments based on these considerations. Of course, on a stand-alone basis, you should implement the EOQ principle to reduce inventory costs.
The ideal level of number and frequency of orders for a given level of demand is defined as Economic Order Quantity. Economic Order Quantity calculates the number of charges needed based on ordering and holding costs. Companies utilize it for cash flow planning, inventory cost minimization, and determining the reordering point for a corporation.