How Economic Order Quantity Can Streamline Your Procurement Processes
Inefficient procurement processes can cause a significant hit to your company’s bottom line. One of the most effective methods to optimize and streamline these processes is implementing economic order quantity. But what is economic order quantity, how can you calculate it, and how can it benefit your business?
This blog will help you better understand economic order quantity and its profound impact on your procurement process flow, inventory management, and overall business efficiency.
What Is Economic Order Quantity?
Economic order quantity is a crucial aspect of inventory management. It represents the ideal order size for a company that minimizes the total inventory management cost, which encompasses holding and order costs. By implementing this practice, you can balance holding and order costs and improve the cash flow and working capital.
The Benefits of Economic Order Quantity on Your Procurement Processes
Reducing Inventory Costs
By determining the optimal order quantity, you can effectively minimize the sum of holding costs and purchase order costs. This reduction in total cost can significantly benefit your bottom line.
Optimize Inventory Levels
Economic order quantity also helps in maintaining appropriate stock levels. Making sure your inventory storage is neither excess nor insufficient provides a tactical means of managing inventory.
Improved Cash Flow
By balancing order cost and holding cost, economic order quantity reduces the usage of excessive working capital in inventory, thereby improving cash flow. This is especially beneficial for businesses that rely on their cash reserves for other investments or operation needs.
Efficient Reorder Point
Economic order quantity aids in determining your reorder point, when your inventory level requires replenishment. This ensures continuous order fulfillment while preventing excess stock or out-of-stock scenarios.
Reduced Administrative Burden
Setting up an automatic purchase order for the economic order quantity reduces your administrative efforts and costs associated with frequent ordering. This makes your inventory management process more efficient.
Accurately Meet Customer Demand
Proper implementation of economic order quantity ensures a business can meet customer needs accurately and promptly by maintaining healthy stock levels. Therefore, it helps prevent stockouts and excess inventory.
Forecasting Future Demand
Economic order quantity provides a quantitative basis for forecasting future demand, which can be valuable in the planning of procurement, production, and other related operations.
Streamlined Supply Chain Efficiency
Streamlining order quantity and schedule can also streamline the supply chain management, resulting in more predictable delivery schedules and improved supplier relationships.
Improved Supplier Relationships
Optimum order quantity helps build better supplier relationships by establishing an organized and predictable order cycle.
Better Service Levels
By leveraging economic order quantity, businesses can ensure better service levels through more efficient inventory management. This can lead to higher customer satisfaction and better business performance.
Looking to achieve these benefits and ensure your procurement processes are cost effective? Explore Velocity’s spend management solutions and discover how we can support your practice.
Practical Steps to Apply Economic Order Quantity in Your Business
The first step for using the economic order quantity formula involves gathering pertinent data about your business. This will include annual demand, order cost, and holding cost. Take time to cleanse and standardize your data to ensure accuracy and usability.
Calculate Economic Order Quantity
After you gather your data, calculate economic order quantity using this formula: √(2 Annual Demand * Order Cost) / Holding Cost. This provides you with the optimal order quantity for minimizing costs, which helps you better maintain your procurement process flow.
Determine Reorder Point and Set Safety Stock
After calculating the economic order quantity, set a reorder point. This is the stock level at which a new purchase order needs to be placed to replenish your inventory. It’s typically calculated based on lead time and average daily usage.
To protect against fluctuations in demand or supply, you might also want to keep a safety stock. This extra inventory is kept in the storage to avoid stockouts and ensure seamless order fulfillment.
Assess Supplier Contracts
With the economic order quantity and reorder point on hand, you’ll next need to assess your supplier contracts. An optimal order size means little if your suppliers cannot fulfill your needs on time or if the cost of each order suddenly changes.
A key difference to remember is the relationship between order size and unit price. Some suppliers offer discounts for large orders. Just ensure that the marginal cost of holding extra inventory doesn’t exceed the benefits of the discount.
Monitor Inventory Levels
Implement an inventory management system to keep an eye on your stock levels and track your ordering patterns. Such systems use alerts to notify inventory managers when the stock reaches the reorder point and it’s time to place a new order.
Evaluate Results and Adjust as Needed
The final step in applying economic order quantity involves regularly reviewing your results. Inventory needs might change with seasonal trends, new product lines, or changes in customer behavior. Adjust your calculation as your data changes.
Streamline Your Procurement Processes With Velocity Procurement
At Velocity Procurement, we strive to help you optimize your procurement processes through strategic advisory and outsourced support services. Leveraging our expertise, you can maximize efficiency while minimizing costs in your supply chain. Whether you’re seeking cost savings, improved supplier relationships, or enhanced inventory management, Velocity Procurement can help.
If you’re ready to take advantage of the benefits of economic order quantity, reach out to Velocity today to take your procurement strategy to the next level.