Economic Order Quantity
EOQEconomic Order Quantity (EOQ) is the ideal order size a company should purchase to minimize its total inventory costs, including holding and ordering costs.
Economic Order Quantity (EOQ) is a calculation used in inventory management. It determines the optimal quantity of units to order at one time. The goal is to find a balance between two competing costs. These costs are the expenses of ordering inventory and the expenses of holding inventory.
Ordering too frequently in small batches increases ordering costs (e.g., shipping, processing). Ordering infrequently in large batches increases holding costs (e.g., storage space, insurance, obsolescence). EOQ identifies the order quantity that minimizes the sum of these two costs. This helps maintain a steady flow of materials for production without tying up excess capital in stock.
On the shop floor, using EOQ helps prevent stockouts that can halt production lines. It also avoids overstocking, which consumes valuable warehouse space and risks material damage or spoilage. For example, a CNC machine shop can use EOQ to determine how many blocks of aluminum to order. This ensures they have enough raw material for jobs without filling their storage area with metal that will not be used for months.
A furniture maker uses 20,000 wood screws annually. The cost to place an order is $25, and the annual holding cost per screw is $0.02. Using the EOQ formula, their ideal order quantity is 5,000 screws per order.
What costs are included in holding costs?
Holding costs include storage space rent, insurance, taxes on inventory, material handling, and costs related to spoilage or obsolescence.
What costs are included in ordering costs?
Ordering costs include the clerical costs of preparing a purchase order, transportation fees, receiving and inspection labor, and processing payments.
How often should I recalculate EOQ?
You should recalculate EOQ whenever its core assumptions change. This includes significant shifts in annual demand, ordering costs, or holding costs.
Does the basic EOQ formula account for supplier discounts?
The standard EOQ formula does not account for quantity discounts. Other models can be used to compare the EOQ with the costs at different discount levels.
Is EOQ the same as a reorder point?
No. EOQ determines how much to order. A reorder point determines when to place the order based on inventory levels and lead time.
Inventory Turnover Ratio
The inventory turnover ratio measures how many times a company sells and replaces its inventory over a specific period.
Just-In-Time
JITJust-In-Time is a production strategy where items are created or delivered only as they are needed, minimizing inventory.
Material Requirements Planning
MRPMaterial Requirements Planning (MRP) is a system that calculates the materials and components needed to manufacture a product based on production schedules.
Reorder Point
ROPThe reorder point is the inventory level that triggers a new order to replenish a specific item.
Safety Stock
Safety stock is extra inventory kept on hand to reduce the risk of a stockout caused by supply and demand volatility.