This document describes what the economic order quantity (EOQ) is and what replenishment methods can be used when calculating EOQ. For information about how to calculate the EOQ, see About working with inventory calculations.
The following sections are included:
EOQ
Economic order quantity (EOQ) determines the amount of an item to be purchased at one time. Its goal is to minimise the combined cost of acquiring and carrying inventory. It has nothing to do with when it is time to make a purchase, just how much that should be purchased.
The EOQ (or replenishment) methods available in Inventory Control are:
- Wilson
- Period dependent
- Demand control
These methods are described in section Replenishment methods. For information on the calculations involved, see Inventory control formulas.
The EOQ is used in various ways in the reorder point model of Inventory Control. It is also used for purchasing as well as internal replenishment.
Rules for purchase price retrieval in EOQ
Besides basic supplier information it is possible to use the following parameters to retrieve EOQ:
- Purchase price
- Quantity specific discounts
- Contract prices
For additional information, see the Panel help when simulating EOQ.
EOQ storage
The calculated EOQ is stored per item/warehouse record in the Item file, the Inventory management panel. It is calculated when the Inventory calculations program is run.
EOQ manual override
A manual override EOQ can be established in the Item file by entering the desired override value in Manual EOQ on the Inventory management panel for the item/warehouse record. If you enter a value here, it is used in all places in the system where an EOQ is needed. You also specify how long the manual override is to be used by entering an end date in End override date below Manual EOQ on the same panel. You can enter the value 999999 in End override date to indicate that the override is to continue indefinitely.
The calculated EOQ is still updated in the system, but it is not used anywhere as long as the manual override applies.
EOQ error calculations
By entering a percentage in Maximum deviation in the Replenishment control code table, you activate an error test for the EOQ calculation for the item/warehouse combinations linked to the control code record that you are working with.
The system then checks the previous EOQ against the present period EOQ. If the difference between the two exceeds the maximum deviation percentage, then a report line is printed on the Inventory calculation error control report, and EOQ error in the Item/Warehouse file is set to YES. If there is no error, this field will be set to NO.
Note: If no maximum deviation is entered in Maximum deviation in the Replenishment control code table, then the system cannot run an error test.
Replenishment methods
The following replenishment methods can be used in the calculation of EOQ:
Wilson method
The Wilson method seeks to minimise the total cost of replenishing stock. There are two cost components involved. They are the ordering cost which is the estimated total cost for placing one order line, and the stock carrying cost which is the cost of having capital tied up in stock.
Ordering cost and the cost of having stock on hand are inversely related. That is, to minimise ordering costs you will need to purchase large quantities per order, reducing the total number of orders. But by reducing ordering costs in this manner, you increase the number of stock you have on hand, and increase the cost of tied up capital.
The Wilson method finds the optimum balance between these two costs. It adds the cost components together and selects the quantity (EOQ) that gives the lowest total cost.
The Wilson method is based on a fairly smooth demand pattern and will function best under those circumstances.
Period dependent
The Period dependent method is a modified version of the Wilson method that handles large fluctuations in demand. The Wilson formula is applied to calculate the best quantity to purchase, as described in the previous section. Wilson minimises the cost over one year, by analysing the year forecast from the Item file.
In the Period dependent method, the Wilson quantity is related to the total year forecast to get a time slice of one year that should be covered with every Wilson purchase. From this, you know how many days’ consumption per average over the year to buy.
The final step is to look in the Forecast file to see what the expected demand is for the number of days that we want to cover at this time. This means that when the near future forecast is higher than average, the Period dependent method will give a higher quantity than the Wilson method. If the near future forecast is lower than average, the period dependent method will yield a lower quantity than the Wilson method.
Demand control
Demand control is a simplistic “rule of thumb” method, which does not try to minimise cost as in the previous two methods. In demand control, an average monthly forecast is calculated from the year forecast in the Item file. Using the average monthly forecast, the quantity to purchase is calculated as the forecasted demand during a specified number of months.
EOQ time factor
EOQ is calculated in the Inventory calculations program, at the beginning of each new forecast period. If you recalculate the EOQ at any later stage in the same forecast period you will get the same result, unless you have changed any methods, parameters or basic data. The Period dependent method is one exception to this rule, as explained below.
If you are using the Period dependent method, then the number of days demand to cover is used to retrieve the EOQ. Via the Wilson EOQ, the system calculates the number of days forecasted demand that you will need to purchase. This forecasted demand is then retrieved from the Forecast file, starting with the first day outside of replenishment time, and adding up the forecasted demand for the specified number of days.
The first day outside of replenishment time moves ahead one day for each day the system moves through the present forecast period. Therefore, if you recalculate EOQ (using the Period dependent method) at a later time in the same forecast period, you could get a different value for the amount of forecasted demand to retrieve. This can happen if the specified number of days demand to cover starts in one forecast period and ends in the next forecast period.
To avoid this, the replenishment time is always measured from the first day of the present forecast period, thereby making the retrieved forecast demand (which is the EOQ) the same value, no matter when you calculate the EOQ in the forecast period.
This means that the EOQ in the Item file is really an estimate of the true EOQ, when using the Period dependent method.
However, when you run the Purchase suggestion program, EOQ is recalculated using the present date as the start date to use for replenishment time. This means that you can get a different EOQ on the purchase suggestion line than the one in the Item file, especially if it is the end of a forecast period.
Replenishment method guidelines
As with forecast, it is difficult to define rules to determine which method is best. Listed below are a few guidelines to help you:
- The Wilson method is a well-known method for calculating EOQ. However, it assumes that the demand pattern is relatively smooth. It produces the best results for items with this characteristic.
- For items that do not have a smooth demand pattern, the Period dependent method provides better results.
- The Period dependent method can make adjustments for large variations in demand if you can forecast these variations through season or trend adjustment. Therefore, when using the Period dependent method, it is wise to employ the seasonal or trend adjustment as well.
- Demand control is not a sophisticated method and is therefore easy to understand, track and use.