EOQ (economic order quantity) refers to the inventory management technique of determining the ideas quantity of goods to buy at a time. It helps to lower ordering and carrying costs and also maintains optimum level of inventory. EOQ assumes that demand of the goods, lead time, ordering costs and carrying costs are always constant. In this post we are going to discuss the pros and cons of economic order quantity.
Advantages Of Economic Order Quantity (EOQ)
The main advantages of EOQ can be highlighted as follows:
1. Reduced Ordering And Carrying Costs
One of the key benefits of determining EOQ is to minimize storage and holding costs. It helps to calculate economical quantity of products to be ordered at a time. Ordering the right quantity of goods helps to minimize time, effort and cost of order. So, it is cost efficient method of inventory.
2. Minimize Risk Of Overstocking Or Understocking
EOQ ensures ordering right quantity of goods at the right time that helps to maintain optimum level of stock to meet the market demand. Therefore, it decreases the risk of overstocking or stockouts.
3. Maintains Cash Flow
As we know that EOQ minimizes ordering and carrying costs, it helps to improve cash flow in the business. Adequate casflow helps to maintain proper liquidity that ensures smooth flow of business operations.
4. Waste Reduction
Another advantage of economic order quantity (EOQ) is that it minimizes wastage of materials because it ensures optimum level of materials to be stored. It also helps to buy right quantity of materials at tight time to avoid wastage and misuse.
5. Increased Earnings
Because of optimum orders, reduced costs and wastage minimization, it increases the earnings of the firm.
Disadvantages Of Economic Order Quantity (EOQ)
The major disadvantages of EOQ are as follows:
1. Difficult To Calculate
It requires algebraic calculation to determine EOQ. So, good mathematical knowledge is required to obtain exact EOQ. Several figures should be calculated to find out economic order quantity. Therefore, it is complex and time consuming.
2. Based On False Assumptions
It assumes that demand, ordering and carrying costs and lead time remain constant but it is rarely happens in real-world.
3. Regular Monitoring
It requires regular monitoring of stock level. So, it consumes more time and resources.
4. Not Suitable
It assumes constant flow of inventory which is not applicable for growing businesses. It may create shortage of materials for rapidly growing firms.
5. Possibility Of Shortages And Overages
It will be difficult to determine EOQ in case of seasonal demand. It may result in shortage or overage of inventory if demand is not predictable.
Pros And Cons Of EOQ In Brief
Pros
* It reduces holding costs
* It lowers the chance of stockouts
* It maximizes the profit
* It improves cash flow
* It simplifies the procurement process
Cons
* It is complicated time consuming method
* It is based on unrealistic assumption
* It is not suitable for fast growing company
* It ignores seasonal demand
* It requires regular monitoring
