How To Master Inventory Management Of DME
- Volume 17 - Issue 10 - October 2004
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Understanding The EOQC Calculation
The mathematical formula for EOQC is the square root of two multiplied by SO/C, in which S is the annual usage or purchases in units, O is the cost per order and C is the annual carrying cost per unit.
S = Annual usage or purchase in units. Typically, annual purchases in units and cost per order are based on historic estimates. However, better forecasting and reduced lead times to operate with reduced inventory stock can also decrease inventory levels and annual use.
O = Cost per order. Order cost is the sum of the fixed costs that are incurred each time one orders a DME item. These costs are not associated with the quantity ordered, but the physical activities required to process the order. This would include the costs to enter the purchase order and/or requisition, any approval steps, the cost to process the receipt, incoming inspection, invoice processing and vendor payment. In some cases, a portion of the inbound freight may also be included in order costs.
The time spent checking in the receipt, entering the receipt and doing any other related paperwork would also be included in order costs, while the time spent repacking materials, unloading boxes or trucks and delivering items to satellite offices would not. Inbound quality inspection — in which a percentage of the quantity received is examined — would include the time to get the specifications and process the paperwork, but not include the actual time spent inspecting the DME items.
One must also include the time associated with creating the purchase order, approval steps, contacting the vendor, expediting and reviewing order reports. All time spent dealing with vendor invoices would be included in order costs. Also be aware that e-procurement, vendor-managed inventories, bar coding, radio frequency identification devices (RFIDs) and vendor certification programs can also reduce costs per order.
C = Annual carrying cost per unit. Also called holding costs, carrying cost is the annual cost per average on-hand inventory unit. There are several primary components of carrying costs that may represent a source of lost profits. These include rent, utilities, insurance, taxes, employee costs and the interest rate and opportunity costs of having office space or capital tied up in DME. For the purpose of the EOQC calculation, if the cost does not change because of the quantity of inventory on hand, it should not be included in carrying costs.
Case Example: How To Implement EOQC
Suppose a large tertiary podiatry clinic performs a good deal of surgery and uses 10,000 self-absorbing bone fixation pins every year. Historically, it is known that the cost per pin is $200, and the annual inventory carrying cost per pin is $10. According to the above formula, the EOQC is 632, as follows:
2 (10,000)($200)/$10 = $400,000
Square root of $400,000 = 632
In other words, there are 16 orders per year (10,000/632 EOQC). The time between each order is 3.3 weeks (52 weeks/16 orders). Therefore, the vital economic questions of when and how much DME to order have been answered.
Prior to final implementation, one must run the EOQC numbers using samples that are representative of the office’s DME inventory base. This will help determine the overall short-term and long-term effects the calculation will have on office warehouse space, cash flows and business operations.
Keep in mind that dramatic increases in inventory levels may not be immediately feasible. If this is the case, you may temporarily adjust the formula until you can make arrangements to handle the additional storage requirements and compensate for the effects on office cash flow. If the projection shows a decreasing inventory level and increasing order frequency, you may need to evaluate staffing, equipment and process changes to handle the increased activity. Finally, one should evaluate the values for order costs and carrying costs at least once per year, taking into account any changes in interest rates, storage costs and operational costs.