Order Quantity and Inventory Costs: Are You Aware of Economic Order Quantity?

 
Orders and inventory have a correlation, such that orders decrease when there is excess inventory and increase as inventory becomes insufficient. Economic order quantity is similarly established from the relationship between ordering and inventory. Inventory management plays a major role, and racks that can make inventory management smart have now appeared.

In this second installment of our general theory series on inventory management and order management, we will explain the fixed-quantity ordering method, which is one type of inventory management method, along with its advantages and drawbacks, and economic order quantity. If you are considering implementing an inventory management system, please use this article as a reference. 

Types of Inventory Management Methods

There are two types of inventory management methods. The first is the fixed-quantity ordering method, and the second is the periodic ordering method. In this article, we will begin by explaining the former, the fixed-quantity ordering method.
 

What is the Fixed-Quantity Ordering Method

According to JIS, the definition of the fixed-quantity ordering method is "an inventory management method in which a predetermined fixed quantity is ordered when the ordering time arrives." It is also called the reorder point method and may be written as ROP (Re-Order Point) or OP (Order Point). Inventory suitable for the fixed-quantity ordering method is considered to be inexpensive, low in importance, and stable in supply. This ordering method has no variation in order quantity and tends to be utilized for products with balanced supply and demand, such as spare parts and reasonably priced small items. From this background, the fixed-quantity ordering method can be said to be the optimal ordering method for maintaining a constant inventory level. 

・Advantages of the Fixed-Quantity Ordering Method

The advantage of the fixed-quantity ordering method is that it does not require effort when ordering and can streamline operations. As mentioned earlier, because there is no change in order quantity, order quantities and ordering times can be automated while forecasting demand. For example, by increasing the proportion of the fixed-quantity ordering method for many raw materials and products, ordering effort can be significantly reduced and operational efficiency can be promoted.
 

・Disadvantages of the Fixed-Quantity Ordering Method

Because the order quantity is the same each time, when demand fluctuates due to social conditions or seasonal changes, there is a possibility of leaning toward either excess inventory or stockouts. Additionally, it is unsuitable for items with long procurement periods, and there is also the disadvantage that operations tend to become loose.
 

・Reorder Point

When inventory quantity reaches the ordering level, this is called the reorder point. In the fixed-quantity ordering method, the reorder point is determined in advance. Therefore, it can be said to be an ordering method that does not require much effort when ordering. Accurately determining the reorder point and order quantity in the fixed-quantity ordering method is very important. The quantity that maintains inventory during the period from ordering to receipt is an essential requirement when determining the reorder point. The formula for calculating the reorder point in the fixed-quantity ordering method is as follows:

◇"Average daily usage × Lead time + Safety stock"

Next, the formula for calculating order quantity in the fixed-quantity ordering method is as follows:

◇"Economic order quantity = √(2 × Ordering cost per order × Annual required quantity ÷ Annual inventory holding cost)"

・Safety Stock

This refers to inventory to prevent stockouts due to consumption variations. Safety stock is also important when calculating the reorder point. The formula for calculating safety stock is obtained by the following method. The safety factor in the formula refers to the numerical value of how much stockout can be tolerated. 

◇"Safety stock quantity = Safety factor × Standard deviation of demand × √(Ordering interval + Delivery lead time)" 

What is Economic Order Quantity

The order quantity that minimizes the total of annual ordering costs and annual inventory costs within a certain period is called economic order quantity, and it is sometimes called economic lot size. Economic order quantity is obtained from the order quantity per order that minimizes the total cost of annual ordering costs and annual inventory costs. From here, we will explain the formula for economic order quantity. 

・Annual Ordering Cost

The formula for annual ordering cost is obtained as follows:

◇"Ordering cost per order × Number of annual orders"

・Annual Inventory Cost

The formula for annual inventory cost is obtained as follows:

◇"Inventory holding cost per unit × Average annual inventory quantity"

By calculating the above two costs as "Annual ordering cost = Annual inventory cost," economic order quantity can be derived.

How to Streamline Inventory Management

What is particularly important in the fixed-quantity ordering method is to be aware of economic order quantity and not miss the timing of ordering while grasping inventory levels. Methods for obtaining economic order quantity can be found using formulas.
However, using formulas every time requires both time and effort, so it cannot be said to be a good strategy from the perspective of operational efficiency. To solve such challenges, it is necessary to implement a system that promotes operational efficiency, such as the Smart Reel Rack.

 

Summary - Implementing an Inventory Management System is Effective

There must be many companies that want to grasp inventory at the optimal timing at all times. The Smart Reel Rack is a system that has taken shape from the voices of such companies.
For example, because LEDs light up starting from reels with the oldest receipt dates, operational efficiency can be realized. Additionally, when the required number of reels is registered in the system, when the quantity falls below the required number, an issue list can be automatically generated, contributing to cost reduction.