When it comes to inventory management, businesses need to be as efficient as possible while also remaining profitable. This means minimizing the time and money spent on inventory management, while also making sure that they do not lose too much money if inventory runs out before being sold. The economic order quantity model helps businesses achieve this balance through the use of mathematical formulas and algorithms. What is EOQ? EOQ is a strategic purchasing technique that businesses use to minimize their inventory costs while ensuring they have enough product on hand to meet customer demand. It determines how much inventory you need to keep on hand based on factors like customer demand and lead time. While manufacturers determine EOQ through a calculation of their own, there are some basic guidelines to follow when determining your EOQ for your specific business. Here’s how it works. First, find out what percentage of your sales revenue comes from repeat customers. For example, if 40 percent of your revenue comes from repeat customers who buy again within 30 days of their last purchase, then that’s good news: It means you can count on steady sales each month without having to worry about huge spikes in demand (and corresponding spikes in costs). If repeat customers make up less than 10 percent of your sales revenue—as they do for many startups—then you probably want to order more frequently than once per month. Why calculate EOQ? If you’re buying products in bulk and selling them individually, EOQ can be a great way to save money. For example, if you’re an ice cream store that buys half-gallon containers of milk from a dairy co-op, EOQ will help you calculate how many units of milk to order at one time. You should be sure to buy enough milk so that you have enough product on hand (say four containers) to meet customer demand for about a month without having to replenish your stock. In other words, if it takes 10 days for customers in your area to consume four containers of milk, then order 12—you should have a full month’s worth available on hand. How to calculate EOQ The formula for calculating EOQ is pretty straightforward: It is the ratio of annual demand for a product, multiplied by the product cost, divided by its average inventory level. For example, if you wanted to figure out how many boxes of widgets you should order each year to minimize your costs, you’d do something like this: (Annual demand) x (Cost per unit) ÷ (Average inventory). Let’s say we had 25 orders per year and it cost $1 to stock a widget and we had an average inventory of 100 widgets. Our equation would look like: 25 x $1 ÷ 100 = 5 units. In other words, we should order 5 units of widgets every year—our EOQ. Limitations of the EOQ model Although EOQ is a very useful inventory management tool, it is not without challenges linked to it. First, it is difficult to factor in demand fluctuations. Using the EOQ model would be relatively easy for a business that has consistent demand for inventory items throughout the year—but not for those with seasonal demand. To stay on top of demand fluctuations you would need to recalculate your EOQ regularly, and if you have a large number of SKUs to manage, this could become a time-consuming and impractical task. Second, the EOQ model treats all inventory items the same, regardless of their value to the business. It assumes you need to stock every item with equal importance and assumes that every item has fixed costs that never fluctuate. As a result, you may end up wasting valuable space on items that you don’t need to have in stock at the expense of running out of your best-sellers. Lastly, the EOQ model does not take into consideration supplier lead times and minimum order requirements. Conclusion By using EOQ for your business, you can improve your overall inventory management process. By ordering the right amount of inventory instead of guessing what to order, you can reduce costs, prevent stockouts, and keep your supply chain operating smoothly. The post Economic Order Quantity (EOQ): A Retailer Must-Know appeared first on POP FUEL. from http://clipstrip.com/pop-fuel/economic-order-quantity-eoq-a-retailer-must-know/
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