ACCOUNTING

How to Calculate Economic Order Quantity (EOQ)

In managing business stock inventory or what is known as inventory management, we are familiar with the term economic order quantity (EOQ) model. How to calculate inventory with the EOQ formula or also known as order frequency, understand the following example questions.

EOQ in inventory management aims to minimize total costs, as well as save inventory and ordering costs.

This framework used to determine order quantity is also known as the Wilson EOQ Model or Wilson Formula.

Apa Itu Economic Order Quantity (EOQ)?

EOQ or ordering frequency refers to the optimal number of items that must be ordered at a given point in time so that the total annual cost of carrying and ordering these items is minimized.

Simply put – how many products do you have to buy to maintain the supply chain in order to save costs.

EOQ helps companies minimize inventory ordering and holding costs.

As explained by the concept of economics, the lower the cost per unit of product order decreases, the greater the total number of orders.

However, the larger the total order quantity, the higher the cost of storing and managing your inventory.

Purpose of Calculating Economic Order Quantity (EOQ)

The purpose of calculating EOQ in a manner similar to the order frequency formula is to identify the optimal number of product units to order.

If this is achieved, the company can minimize the costs of purchasing, shipping, and storing units.

The EOQ formula can be modified to specify different production levels or order intervals, and companies with large supply chains and high variable costs use certain software algorithms to determine EOQ.

How calculate EOQ is an important cash flow tool. The formula can help companies control the amount of cash tied up in inventory balances.

For many companies, inventory is their greatest asset besides their human resources, and the business must carry sufficient inventory to meet customer needs.

If EOQ can help minimize inventory levels, the cash savings can be used for some other business or investment purpose.

The EOQ formula determines a company’s inventory reorder point. When inventory drops to a certain level, the EOQ formula, when applied to business processes, triggers the need to order more units.

By defining reorder points, businesses avoid running out of stock and can continue to fulfill customer orders.

If the company runs out of inventory, then there is a shortage cost, which is lost revenue because the company’s inventory is not sufficient to fill orders.

Inventory shortages can also mean the company loses customers or clients will order less in the future.

Cost Category in Economic Order Quantity (EOQ) Model

In the EOQ model of inventory management, there are several categories of costs that influence the calculation, including:

Booking fee

Also known as purchase fee or set up fee. Represents the number of fixed costs incurred each time an item is ordered. These costs relate to the physical activity required to process orders. The nature of this ordering cost is constant, and does not depend on the number of items ordered. Included in this booking fee are:

– Order preparation fee

– The cost of sending or assigning employees to place orders.

– The cost of receiving the ordered material

– Order payment settlement fee.

Recorded costs

Also called holding costs, carrying costs are a type of cost associated with inventory held in warehouses. It consists of costs related to inventory investment and storage costs.

Some items that influence and are included in this recorded cost are interest, insurance, taxes, and storage costs such as warehouse rental fees, electricity costs, damage costs, and so on.

 

The formula for calculating EOQ

Here’s how to calculate EOQ or order frequency using the formula:

EOQ = square root of: [2SD] / H

S = Setup costs (per order, generally including shipping and handling)
D = Demand rate (quantity sold per year)
H = Holding costs (per year, per unit)

Sample Questions on How to Calculate Economical Order Quantity (EOQ)

The following is an example of a question on how to calculate EOQ or order frequency using the formula:

PT Maju Jaya in the coming year will need 240,000 units of raw materials. The price of raw materials per unit is Rp. 2,000.

The ordering cost for each time you place an order is Rp. 150,000, while the storage cost is 25% of the average inventory value.

Requested:

A a. What is the most economical order quantity (EOQ)?

b. How many orders must be made in a year?

c. How many days once does the company place an order (1 year = 360 days)?

Answer :

a. EOQ = square root of 2 x 240,000 x 150,000 / 2000 x 25%

EOQ = 144.000.000

EOQ = 12.000 Unit

b. Orders made in a year:

240,000 : 12,000 = 20 x order

c. If 1 year = 360 days, then the order is made = 360: 20 = 18 days.

Factors to Consider When Calculating EOQ

The order frequency formula or EOQ is a relatively simple way to calculate your reorder points, but there are other factors to consider when using it:

  • How consistent are your requests? If they vary widely, ordering only on a cost-effective basis can lead to out-of-stock when demand increases, and overstock when demand falls.
  • Can the purchasing team and warehouse staff manage the order frequency recommended by the EOQ calculation?
  • Do your inventory items vary in value and importance to the business? If the answer is yes, maybe the reordering parameters don’t have to be all the same?
  • If you have a minimum order quantity to reach with a particular supplier, an order based on EOQ may not be possible.
  • Is your supplier’s lead time always on schedule? Otherwise, you may need to adjust the safety stock level regularly to prevent out-of-stock when delivery is late.

Calculating EOQ with Journal Accounting Software

If you use Journal accounting software, calculating economic order quantity to help this part of inventory management will be faster and easier.

The cost and stock features of the Journal will help you integrate directly and find out at once how much it costs and the availability of stock needed.

In addition, the cost feature can also schedule recurring payments according to the needs of inventory orders that have been calculated and agreed upon.

Get all information about cost features and stock features in Journal stock software to warehouse application features here, and enjoy the convenience of managing inventory and calculating orders to invoicing based on economic order quantity for your company.

Now that’s an explanation of EOQ or also known as ordering frequency, how to calculate, formulas, and examples of questions.

Hopefully, the information above is useful. Follow Mekari Jurnal‘s social media for more information about the business, finance, and accounting.

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