Determine your order size
The latest time you need to purchase new products is determined by the supplier's delivery time. But how much do you buy in?
In this class, you'll learn how to determine your optimal order size.
Order cost
Order costs are the costs you incur, regardless of the size of your order, to get the products into your warehouse.
Ordering costs are never 0 euros. This is because every order involves a number of fixed operations and therefore costs.
We call these costs order fees, costs you incur per order, regardless of the number of products you order.
But how do you determine these costs?
Go over for yourself what needs to be done before new stock is in your warehouse. For example, you spend time (and therefore money) placing an order and taking delivery.
Ordering costs include:
- Internal costs you incur when placing an order (hours)
- Internal costs you incur when taking delivery (hours)
- Supplier start-up fees for processing an order
- Fixed logistics costs
| Fixed order fees (internal) | € 5,- |
| Fixed reception fees (internal) | € 10,- |
| Fixed order cost supplier | € 7,50 |
| Fixed logistics costs | € 22,50 |
| ——– | |
| Fixed cost per order | € 45,- |
Internal ordering costs
To determine internal ordering costs, you can add the purchasing department budget and merchandise receipts together and divide by the number of orders.
No procurement and receiving departments? Then figure out how much time you spend on these operations and multiply it by an internal hourly rate, say 25 euros per hour.
Stock Costs
Inventory costs are the costs you incur, directly or indirectly, to keep products in stock. Inventory costs are always expressed as a percentage per euro of the inventory value. Inventory costs consist of three components: space, risk and interest. But how do you calculate these?
Space
Space is about the size of your warehouse. After all, the more products you want to stock, the more space you need. In addition, large products, such as drones, take up more space than bennies, for example. If you order more frequently, you need less warehouse space and thus save on inventory costs.
Risk
Risk is the cost you incur when your inventory becomes obsolete. Or in other words, the damage you incur if you can no longer sell products.
Fire or theft can be a cause, or simply the fact that your product is not catching on.
Note
The more products you want to keep in stock, the more likely you are to run out of products to sell. Depending on the product, the risk percentage varies between 5 and 10 percent of your inventory value. Among other things, competition and trends affect the risk percentage.
Interest is the cost of your capital. This can literally be interest because you borrowed money from the bank to purchase goods. But interest can also be opportunity costs: the money you're missing out on because you weren't able to invest in marketing or AdWords, for example. After all, you can only spend your money once. As a rule of thumb, you can use between 5 and 10 percent interest.
To calculate the total cost of inventory, add the percentages for space, risk and interest. Interest and risk are independent of the type of products, but actually differentiate by company. The percentage for space, as mentioned above, actually varies by product. Below we take the example of storage space for drones: 10%. For the risk we charge 10% and for our interest rate at the bank is 5.
Ordering costs versus inventory costs
To determine order size, shop owners choose an ideal ratio between order costs and inventory costs to minimize costs.
Scenario 1: 2 orders of 40 drones at €72.
With larger orders all at once, you save on ordering costs, while your inventory costs increase.
Order costs: 2 x € 45 = € 90.
Stock costs: 0.5 x 40 x € 72, - x 25% = € 360, -
Total: € 450.
Scenario 2: 8 orders of 10 drones at €72.
More smaller orders typically means higher total order costs and, on the contrary, lower annual inventory costs.
Order costs: 8 x €45 = €360.
Stock costs*: 0.5 x 10 x € 72, - x 25% = € 90, -
Total: €450.
*Explanation of inventory costs:
To determine inventory costs, assume average inventory (0.5 x number of products ordered). In the case of scenario 1, in the period following an order, you have an average of 5 drones in stock. At the beginning 10, at the end 0.
To calculate the average stock value of this product, we multiply the average stock by the purchase price (0.5 x 10 x €72).
To determine the final inventory cost, we take from this the previously determined percentage for Space, Risk and Interest (25%).
Optimal Order Size
How often you order new drones depends on many factors. In the calculation example, you can see that it doesn't matter whether you order 10 drones 8 times a year or order 40 drones twice a year. In both cases, the total cost (inventory costs + ordering costs) is €450. The optimal order size is reached at 4 times 20 drones. The total cost is then minimized (€360).
Optimal: order 4 times 20 drones at € 72.
Order costs: 4 x €45 = €180.
Stock costs: 0.5 x 20 x € 72, - x 25% = € 180, -
Total: € 360
Are we there now? Not quite there yet. For example, quantity discounts, minimum order size (MOQ) and the addition of new products to the assortment may be reasons to deviate from the above scenario after all.
The impact of a product going out of stock and the amount of demand that can be delivered directly from stock are also factors that can come into play. With specific software, make sure you are prepared.