All of us go to supermarket for purchasing of various household items now suppose supermarket is far from your home than you will make a list of household items that you need so that you purchase all the required household items in one shot so that you do not have to go supermarket often as it involves fuel cost, inconvenience and waste of time if you regularly go to supermarket instead of going once in a month, in case of companies similar concept is applied called economic order quantity which refers to that quantity of goods which company should purchase so that its holding cost as well as ordering cost remains minimum. In order to understand more about this concept, one should look at the advantages and disadvantages of economic order quantity –
Advantages of Economic Order Quantity
Reduce Holding Costs
The biggest advantage of EOQ is that it helps the company in reducing the holding cost of inventory because when the company has EOQ system in place than it does not need to have a big warehouse to store goods as company orders goods in limited quantity so that current production of goods does not come to halt. In simple words, if the company does not follow this method then it has to purchase warehouse or take warehouse on rent besides it will need staff for that warehouse which again involves expenses but due to this system company is able to save all the holding costs related to inventory.
Reduce Ordering Costs
In case of EOQ while ordering goods companies order goods on fixed date which may be fortnightly or monthly which results in reduction in ordering costs because if company orders 10 times in one month than company will have to pay transportation costs, packing costs and other costs 10 times but if company orders goods only 1 time in a month than all costs will incur one time only and not 10 times.
Better Inventory Management
Another benefit of EOQ is that it is a key to better inventory management and when the company can manage its inventory in an effective way than it can reduce substantial operational costs which in turn will lead to more profits for the company. In simple words, EOQ indirectly helps the company in earning profits through a reduction in operational costs associated with inventory management.
Disadvantages of Economic Order Quantity
Forecast of Accurate Demand not Possible
The biggest disadvantage of economic order quantity is that it is based on the assumption that demand for company’s products can be forecasted accurately which in real life is not possible because demand for company’s product never remain static rather it keeps changing and if demand for good produced by the company rises or decreases substantially than having EOQ system in company is of no use.
Immediate Availability of Products with Suppliers
Another problem with EOQ is that it may be possible that supplier does not have raw materials and if the company needs immediate raw material for meeting unexpected demand than it can lead to problems as EOQ system is based on the premise that demand will be constant which can be predicted accurately. In simple words, if the company has good relationships with multiple suppliers than it is not much of a problem, however, if the company is dependent on only 1 or 2 suppliers for its raw material than the company may face trouble following EOQ method.
Requires Continuous Monitoring
Companies in case of economic order quantity have to constantly monitor reorder levels as moment level of raw materials reaches reorder level company has to order goods from suppliers and this is where the company will need to employ staff so as to monitor stock levels which again is a time consuming as well as an expensive process.
As one can see from the above that economic order quantity has pros as well as cons and that is the reason why any company thinking of taking a decision of having economic order quantity system in place should carefully read above points and then take the decision whether to implement this system or not.