Optimal Production Quantity Formula Definition
Optimal Production Quantity is the minimum amount of order that has to be produced to avoid excess storage cost and blockage of funds. It is also referred to as Economic Order Quantity (EOQ).
Significance of Optimal Production Quantity Formula
Calculating optimal production quantity is the most effective way to manage inventory. It holds utmost significance in businesses, including:
- It minimizes the storage and holding costs
- The optimal production quantity formula gives you a better understanding of the production
- It helps you understand the customer’s demand.
Applications of Optimal Production Quantity
Companies using optimal production quantity formulas can easily reduce the deadstock amount and increase company revenue. Some general applications for formula include the following:
- By implementing the formula, you can keep optimal quantity and reduce the space in your warehouse for a limited time, reducing the holding cost
- It allows you to have a better look at the production because of the small quantity of inventory
- Having data on the optimal quantity, you can keep only the required quantity, lower inventory costs, and increase the company’s revenue
Optimal Production Quantity Formula
Optimal production quantity formula =
Square root of [(2xDxO )]
H
where,
D = Annual demand for the product
O = Order cost per purchase
H = Annual holding cost per product
Understanding With the Help of an Example
For example, you sell 1000 TVs each year. Your company has to pay ₱4 per unit to hold these TVs in inventory. For this, the order cost turns into ₱2 per purchase.
The optimal production quantity = Square root of [(2x1000x₱2)/₱4]
= 31.6
Thus, the optimal production quantity is 32 units (approximately) of TVs.
Inference
The optimal production quantity formula helps you manage the inventory and gives you a clear picture of the SKUs present in your warehouse. Moreover, it also helps you cut down your holding cost.