QS Study

Importance of Economic Order Quantity

Economic order quantity (EOQ) is the order quantity.bf inventory that minimizes the total cost of inventory management. It is a measurement used in the field of Operations, Logistics, and Supply Management.

(a) Minimizes Storage and Holding Costs

Storing inventory may be, expensive for small business owners. The main advantage of the EOQ model is the customized recommendations provided regarding the .most economical number of units per order. The model may suggest buying a larger quantity in fewer orders to take advantage of discount bulk buying and minimizing order costs. Alternatively, it may point to more orders of fewer items to minimize holding costs if they are high and ordering costs are relatively low.

(b) Specific to the business

Maintaining sufficient inventory levels to match customer demand is a balancing act for many small businesses. Another advantage of the EOQ model is that it provides specific numbers particular to the business regarding how much inventory to hold, when to re-order it and how many items to order. This smoothes out the re-stocking process and results in better customer service as inventory is available when needed.

(c) Complicated Math Calculations

The EOQ model requires a good understanding of algebra, a disadvantage for small business owners lacking math skills. Additionally, effective EOQ models require detailed data to calculate several figures. For example, the key formula of the model calculates the square root of 2DS/H, where D is the number of units purchased annually, S is the fixed ordering charge, and is the holding cost per unit. Rent or mortgage payments, utility costs and property taxes are required just to calculate H.

(d) Based on Assumptions

The EOQ model assumes steady demand of a business product and immediate availability of items to be re-stocked. It does not account for seasonal or economic fluctuations. It assumes fixed costs of inventory units, ordering charges and holding charges. This inventory model requires continuous monitoring of inventory levels. The effectiveness of the basic EOQ model is most limited by the assumption of a one-product business, and the formula does not allow for, combining several different products in the same order.

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