Many people do not know what economic order quantity (EOQ) is, other than it sounds like and economical way to order products, so to illustrate what EOQ is consider the following example.
Ryan has an industrial tool supply business and commonly sells construction adhesive that he buys for $19.24 per unit. Ryan’s supplier can generally deliver this construction adhesive in 4 to 5 business days. Because of this, Ryan has established the 5th and the 20th as the dates he will place orders to his supplier, ordering enough supply to support his demand over those 15 days. Ryan anticipates his monthly demand to be approximately 45 units based on historical demand, therefore every 15 days Ryan orders 22-23 units depending on need.
This is common practice among distributors or wholesalers and seems logical; order what we need but not too much because if we need more we can get more fairly quickly. In addition, Ryan thinks if we don’t need to spend the cash let’s not. With each order Ryan places for this construction adhesive, his supplier charges him a deliver fuel surcharge fee of $85 which Ryan adds to the cost of the product and simply passes it on to his customers.
With this conventional thinking of ordering product twice a month, Ryan spends $2,040 (24 orders * $85) per year on orders. This is where economic order quantity comes into play, Economic Order Quantity is used to optimize the order quantity based on the cost to place an order vs. the cost to carry the item. EOQ will never reduce the order quantity, but it may increase the order quantity if it determined that it’s better to put more on the shelf and order it less frequently.
Based on this same scenario, if Ryan where to use economic order quantity he would order 138 units of construction adhesive placing 2.6 orders per year. Placing only 2.6 orders per year Ryan’s ordering costs would be $225 (2.6 orders * $85) per year. Using EOQ Ryan could save his company $1,815 in ordering costs. This is all based on Ryan’s carrying cost of 25% and the cost of money. For Ryan to maximize the return on his investment, Ryan should be ordering 138 units of construction adhesive 2.6 times per year.
EOQ Formula
Cost to Place Order
The Cost to place an order could be as simple as a single cost or multiple costs added together. A simple example, maybe too simple, is the Uniteds States Postal service. They have Priority Mail Flate Rate which simply states, "If it fits, it ships!" This means that if you put one small item in the box or ten small items in a box, the shipping cost is the same. Now take this to a larger scale. Say you order a truck load of material and are chareged a delivery fee or even a fuel surcharge fee. Typically whehter you order a full truck or a less than full truck they charge you the same. This also applies to a shipping container from over seas. Typically charges are based in the container itself. Whether the container is full or not it takes up the same amount of space on the boat.
Expected Monthly Demand
The expected monthly demand can be difficult to know. However, knowing what to order, when to order, and how much to order is made easy with Infor Distribution software. Replenishment reports let purchacing agents know the answer to these three questions. The software tracks usage and predicts or projects what your expected monthly demand will be. This insight allows businesses to keep the right amount of inventory to meet customer demand.
Carrying Costs
Carrying costs refer to the total cost of holding inventory. The cost is what a business will incur over a certain period of time, to hold and store its inventory. The carrying cost of inventory is often described as a percentage of the inventory value. Much like a loan from the bank, inventory is viewed the same way. Inventory is simply what you have convereted your cash to, it is still an asset and has value to you but has consumed that cash resource like a loan. In addition, carrying costs also take into consideration taxes, employee costs, depreciation, insurance, and the cost of insuring and replacing items. Generally, inventory carrying costs are approximately 25%.
Cost of the Item
Item cost is much easier to identify, it is simply what you pay for a particular item.
Multiple Items
The simple example above helps illustrate the costs associated with ordering a single item from a single vendor. In many cases, distributors will order multiple items from a single supplier or manufacturer which helps reduce the impact of a shipping fee or freight costs. Infor's distribution software will recognize this and apply the economic order quantity across the entire order from a supplier, whether that is for a single item or one hundred different items. EOQ is calculated across all items and all suppliers giving distributors the best possible information to order products, delivering the highest return on dollars invested in inventory.
Employee Costs
Using Infor Distribution software the purchasing process will be streamlined and simplified. Infor Distribution software will track usage, recognize trends and seasonality, and generate suggested purchase orders. Processes that were once done manually by a team of purchasing agents can be done with a much smaller team or even single purchasing agent. Employee costs represents additional cost that should be added to the cost of ordering. These costs can be significant and should not be overlooked.
Bottom Line
Infor Distribution software will minimize costs using economic order quantity across all orders and items. Infor Distribution software will also reduce the amount of time spent managing the purchasing process requiring less man power to manage the purchasing cycle.
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