Question joseph oseni Finance & Economics

What is the efficacy of economic order quantity in a small business?

What is the efficacy of economic order quantity in a small business?

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Answer Expert #26342

To be efficient, businesses need to manage inventory in an effective manner. One approach used increasingly by larger businesses is economic order quantity (EOQ). EQQ involves calculating the most cost effective level for ordering input requirements (Axsater, 2009). However, practices used by larger businesses are not always viable for smaller firms, to determine this, it is necessary to look at the concept and then apply it to the SME environment.

The aim of EOQ is to minimise the overall costs associated with ordering and holding inventory items (Axsater, 2009). The EOQ is calculated taking into account all the different costs associated with the purchase and holding of inventory, to determine optimal order levels (Chen, Cardenas-Barron and Teng, 2014). Costs included in the calculation include the cost of placing the order, discounts for larger purchases, delivery costs, labour costs for receiving orders and managing the inventory, storage costs, interest charges and cost of capital tied up in stock (Muckstadt and Sapra, 2010; Bozarth, 2011). These inputs result in a calculation identifying the optimal order levels to reduce the overall costs associated with inventory ordering and holding (Muckstadt and Sapra, 2010).

Theoretically, this can aid any business. However, for high efficacy there needs to be accurate inputs into the calculation to determine accurate optimal order levels (Muller, 2011). Larger businesses are better placed to calculate the indirect costs, such as costs of ordering, and labour associated with holding stock (Muller, 2011). Without accurate inputs the efficacy of EOQ calculated may be comprised. Small businesses also face the problem of greater variability of costs associated with the process (Muller, 2011). Therefore, it is possible EOQ may aid with cost savings for small businesses, but it might not provide the same efficacy levels seen in larger business where there are more transparent and consistent inventory costs.

References

Axsater, S., 2009. Inventory Control. London: Springer Verlag.
Bozarth, C., 2011. Economic Order Quantity Model. [online] NC State University. Available at: .

Chen, S.,, Cardenas-Barron, L.E., and Teng, J., 2014. Retailer’s economic order quantity when the supplier offers conditionally permissible delay in payments link to order quantity. International Journal of Production Economics, 155(8), pp.284–291.

Muckstadt, J.A., and Sapra, A., 2010. Principles of Inventory Management: When You Are Down to Four, Order More. London: Springer Science & Business Media.

Muller, M., 2011. Essentials of Inventory Management. Saranac Lake, New York: AMACOM.