The Economic Order Quantity model solves the "how much" and "when" aspects of ordering inventory. When inventory reaches the zero point, you order just enough to replenish your stock back to its original level. You repeat this cycle throughout the year, never having to decide when to order or how much to order. The decisions are based on preset levels. While this model offers some positive guidelines, you must watch for pitfalls as well.

Assumptions

The EOQ model assumes that demand remains steady throughout the year and that inventory gets used at a fixed rate. If those assumptions hold true, you can order at the same time each month or quarter. However, if demand fluctuates, you may run out of inventory sooner than you anticipate. You also may have to order more than you usually do to meet higher demand, or lower the order to adjust to declining demand. That means you would temporarily have to temporarily abandon the EOQ model when demand fluctuates.

Lead Time

When you run out of stock, you can expect a waiting period until your new stock arrives, even if you order immediately. As a result, the EOQ model can take lead time into consideration and move the reorder date to just before stock runs out. This works well in most cases. However, the model assumes the lead time remains the same for each order. In reality, your supplier could experience delays. Since you carry the minimum amount of inventory if you use EOQ, you could run out during a supplier delay. The solution is to establish reorder dates that take into account your suppliers' reliability.

One-Year Holding Cost

When you apply EOQ principles, you assume that each unit has a cost for warehousing and holding it until you order again. This allows you to predict your inventory expenses. In practice, you will sell some of the inventory much sooner than the reorder date, so you do not actually incur the projected holding cost. You could be showing less profit for your company because you assume the maximum holding expense for each unit of inventory. One way to rectify this is to discount your holding cost to allow for the fact that not all units are being held for the same amount of time.

Quantity Discounts

Because the EOQ method has you order the same amount each time, you do not get to take advantage of quantity discounts and specials your suppliers may offer. If you want the discount, you will have to temporarily suspend your EOQ method and watch inventory levels until it is time to order again. Presumably, since you ordered more to get the discount, it will take you longer to use up your inventory. This means you will have to monitor inventory to decide when to re-order.