December 20, 2013
What is Economic Order Quantity?
Economic Order Quantity is also often referred to as EOQ. It is the optimal number of units to purchase when taking into consideration how many units are sold in a given period of time and the cost to order each unit with holding costs. One important assumption with this model is it assumes a constant rate of demand with no stockouts (stockouts are lost profit and lost sales!). Demand is fairly easy to establish, as we look at the number of past sales in a given period of time, and this is our projection for future demand (there are more complex formula's for forecasting demand and we will touch on them in later articles). The cost of placing an order is determined based on how much time is invested in placing the order; employee time making the order, doing the research, etc. Holding cost, also referred to as carrying cost, is based on how much it costs the company to hold unsold units in inventory. Holding costs include the space the product takes up on the shelves, in the warehouse, money spent and tied up in buying the goods (with interest charges), shrink loss, damage, etc. While there are a large number of industries that use the EOQ model for purchasing decisions, the model is more accurate for some than others.