Economic Order Quantity
Cloud Accounting • September 27, 2019
New ParagraphDo you dread the word “Inventory”? Is your Inventory a “placeholder” for your money?
A large amount of capital, if not the majority of a company’s capital is wrapped up in their inventory
For that reason, it’s incredibly important to control the coming and going of inventory as best you can to minimize losses and maximize profits – which is why we will be bringing you a blog per week on different inventory management techniques.
What is Inventory Management?
Inventory management is a collection of tools, techniques, and strategies for storing, tracking, delivering, and ordering inventory or stock.
Inventory Management Techniques
This week we are focusing on Economic Order Quantity and why it is one of the most popular and effective inventory management techniques you can use to improve your business.
Economic Order Quantity
Economic order quantity is the lowest amount of inventory you want to order to fulfil peak client demand while not going out of stock and without producing obsolete inventory.
Its purpose is to cut back on inventory as much as possible while keeping the cost of inventory as low as possible.
To help you calculate EOQ, here is the formula from Kenneth Boyd, author of Cost Accounting for Dummies:
- Demand: The demand, in units, for the product for a specific period.
- Relevant ordering cost: Ordering cost per purchase order.
- Relevant carrying cost: Carrying costs for one unit. Assume the unit is in stock for the time used for demand.
Important to note that the ordering value is calculated per order. The carrying costs are calculated per unit. Here’s the formula for economic order quantity:
Economic order quantity = square root of [(2 x demand x ordering costs) ÷ carrying costs]
That’s easier to visualize as a regular formula:
Q is the economic order quantity (units). D is demand (units, often annual), S is ordering cost (per purchase order), and H is carrying cost per unit.
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Just-in-Time (JIT) Inventory Management is simply creating what's required, when it’s required, within the amount required.
ABC analysis of inventory is a technique of sorting your inventory into three classes according to how well they sell and how much they cost to hold
Minimum order quantity (MOQ) is the lowest set quantity of stock that a provider is willing to sell. If you can’t purchase the MOQ of a particular product, then the provider won’t sell it to you.
