The benefits of using EOQ
Without continuously improving your inventory management systems, it is easy to fall into the trap of over-ordering or under-ordering inventory. This can result in high holdings costs or even production shutdowns.
EOQ can help businesses avoid these costly mistakes by finding the perfect balance between meeting customer demand and minimizing costs. There are several key benefits of using EOQ to improve inventory management.
Reduced carrying cost
One of the main benefits of EOQ is that it can help reduce hold. These are the costs associated with holding inventory, and they can add up quickly if you have too much inventory on hand. Things like:
- Rent or mortgage payments for storage space
- Interest on inventory loans
- Wages for employees who manage inventory
By using EOQ to calculate the optimal quantity of inventory to order, you can minimize the total direct cost and free up working capital.
For example, let’s say your carrying cost is $2 per unit per year, and you average 500 units in stock. This means your total carrying costs are $1,000 per year.
Now, let’s say you use EOQ to calculate that you should be ordering 200 units at a time. This would reduce your average inventory, and in turn, your total cost associated with holding products would be significantly slashed.
Improved customer service
If you have ever tried to order a specific product only to be met by an “out of stock” pop-up, you know the frustration of not being able to find what you need when you need it. This is called a stockout, and it can be very costly for businesses. Not only do you lose the sale, but you also damage your reputation and risk losing future business.
EOQ can help businesses avoid stockouts by ensuring that there is always enough inventory on hand to meet customer demand. This improved customer service will lead to increased sales and repeat business, adding to lifetime value.
Reduced production cost
Avoiding spoilage or obsolescence is key to reducing production costs. EOQ can do this by helping to optimize inventory levels that are neither too high nor too low.
Too much inventory results in wasted resources like storage space, labor, and materials. On the other hand, too little inventory can lead to production shutdowns, which are even more costly. By using EOQ to find the perfect balance, businesses can minimize their manufacturing costs and avoid these costly mistakes.
Improved cash flow
With these savings in place, businesses will have more cash available to reinvest in other areas of the business or take advantage of opportunities as they arise. This can mean paying off loans, expanding the business, or hiring new staff.
Inventory is a major expense for businesses, so anything that can be done to reduce these costs will positively impact cash flow.
In addition to these financial benefits, using EOQ can also help you reduce the time and effort required to manage your inventory. This is because it provides a standard formula for calculating inventory needs based on known factors.