“EOQ sits at the heart of inventory control, and good use of EOQ intelligence affects many areas of your business – namely cash flow, growth potential, and profitability.”
EOQ, or economic order quantity, is a powerful tool for distributors. ADS Solutions’ distribution management system allows distributors to manage inventory purchasing and stock levels based on desired service levels for specific products. Higher desired service levels typically require higher levels of stock and greater inventory carrying costs. Similarly, lower service levels are associated with lower levels of customer satisfaction. EOQ gives the distributor the ability to systematically set service level inputs and to generate recommended purchasing reports that optimize inventory levels.
“Optimizing your inventory levels” means that for each product and your chosen service level, you keep enough stock on hand to fulfill your customers’ orders in a timely fashion, yet keep your overhead costs to a minimum. The fewer goods you can stock for the shortest amount of time, but still manage to ship all your orders on-time, the better. EOQ sits at the heart of inventory control, and good use of EOQ intelligence affects many areas of your business – namely cash flow, growth potential, and profitability. In its most simplistic form, the equation looks like this:
Where D is your demand; S is your setup, or ordering cost; and H is your holding cost. The kind of EOQ calculated by sophisticated ERP software for distributors is based on a slightly more complicated mathematical equation that takes your safety stock levels, your vendor lead time, the product’s usage rate, multiple contributors to your carrying costs, and your transaction costs into consideration, and generates an optimal (or “economic”) order quantity. That said, the principle is the same as in the mathematical expression above.
Accurate EOQ Depends on Good Historical Data
The more accurate the historical data is that you use to substantiate lead times and usage rates, the more reliable your suggested EOQ-generated order quantity becomes. Properly used, EOQ can be a critical driver of profitability and growth in your business. Volumes have been written about EOQ, and a simplified summary such as this will hardly scratch the surface of this powerful facet of inventory optimization. As with all such tools, though, the better the information inputs, the better the value of the output.
Most ERP vendors like ADS Solutions distributors software will automatically track the transaction data that automatically feeds your EOQ algorithm. If your distribution management system doesn’t do this automatically, here are a few practical tips about how to most accurately track and record some of the information integral to an accurate EOQ calculation. Also remember that EOQ is a tool, a sophisticated and very powerful tool, but a tool nonetheless, so don’t overlook the importance of human interaction and input to the process.
Location, Location, Location
Record the sale and fulfillment of products in the proper location. If you have to move products from warehouse X to satisfy demand in region Y, be sure to associate the sale of this item in your distribution management system with region Y. You can see that if the demand is recorded as having come from warehouse X, then warehouse Y is likely to experience stock-outs in the future.
Note Date of Request – Not Just Delivery Date
Record when the customer wanted the product, even and especially if that date varies from the actual delivery date. Use the features on your distribution management system to help you keep track of seasonal requests that were lost to competitors because of your low inventory. Be sure to track ebbs and flows of orders tied to other predictors, too, like sales of ‘sister’ products.
Start Tracking Unfulfilled as Well as Fulfilled Requests
Record usage for what the customer actually orders. If you are out of stock, then you need to note that, even if you fill the order with another product. If all you record is record fulfilled order, you may not purchase enough to satisfy customer demand in the future.
EOQ Differs With Every Distribution Management System
Many of the more sophisticated ERP distribution software programs available today offer some type of demand forecasting or EOQ functionality; however, each will operate in its own unique way, and none are 100% foolproof. The application of human judgment to a distribution management system’s EOQ recommendation is the last part of this equation – and a critical one at that. Your ERP software should provide sound, logical, suggested economic order quantities, but your buyers need to overlay their professional experience and sound judgment to adjust recommendations based on your own unique business and specific industry, and have the ability to adjust or override system suggestions.