Economic Order Quantity EOQ : Meaning, Working, Formula and Examples

Let’s say you run a small clothing store that carries a popular baseball cap, and you sell 400 caps each year. It costs your company $3 per year to hold each hat in inventory, and the average order cost is $900. Yes, EOQ can be calculated in Excel using the standard formula with demand, holding, and ordering costs.

By keeping the above values in the below tabular equation, we get the total cost with different volumes. As demand is constant, inventory will decrease with usage when it reduces to zero-order placed again. While the Economic Order Quantity (EOQ) formula is conceptually simple, calculating and applying it consistently across a wide product range—especially in fast-paced retail environments—is anything but. While Economic Order Quantity (EOQ) is a valuable tool for optimizing inventory, it’s not a one-size-fits-all solution. There are certain business scenarios where relying solely on EOQ may not deliver the desired results. Madis is an experienced content writer and translator with a deep interest in manufacturing and inventory management.

Formula and Calculation of Economic Order Quantity

The cost to place and process each order is $50, and the holding cost per unit per year is $2. Further, we will calculate holding, ordering, and the number of orders per year and combine ordering and holding costs at economic order quantity. Let’s take an example to calculate EOQ – Economic Order Quantity for a pen manufacturing company where the company’s annual quantity demanded is 400, the holding cost is $2, and the ordering cost is $1.

How To Determine the Inventory Reorder Point

If you want to calculate EOQ, find the square root of 2 times the annual demand (in units) multiplied by the order cost per purchase order, divided by the annual carrying cost or holding cost per unit. The two most significant inventory management costs are ordering costs and carrying costs. Ordering costs are costs incurred on placing and receiving a new shipment of inventories. These include communication costs, transportation costs, transit insurance costs, inspection costs, accounting costs, etc. Carrying costs represent costs incurred on holding inventory in hand.

EOQ Formula

• It’s like a universal tool that businesses of all shapes and sizes can use to save money and run smoother operations.
• The warehouse area takes up 25% of the workshop, therefore the yearly rent for the storage area is $5,000.
• If you want to calculate EOQ, find the square root of 2 times the annual demand (in units) multiplied by the order cost per purchase order, divided by the annual carrying cost or holding cost per unit.
• One of the key features of Flowspace’s platform is real-time inventory visibility with our inventory management software.
• EOQ isn’t just a fancy term – it’s a game-changer for businesses looking to stay ahead of the curve.
• Annual holding cost is the sum of volume per order and holding cost, which can be written as.

Too low quantity will result in loss of sales and too high will lead to blocking of funds that can be used for other more useful investments and areas of business. The calculation also assumes that both ordering and holding costs remain constant. They have historical data showing that they sell an average of 500 smartphones per month (demand rate, D).

How to Use Economic Order Quantity in Inventory Management to Reduce Costs

The efficient Economic Order Quantity (EOQ) models require detailed data to calculate several figures. employer liability for unemployment taxes To minimize holding and order costs, DeMoon should order 49 units. To find out the annual demand, you multiply the number of products it sells per month by 12. Ordering costs refer to all the costs incurred each time an order is placed for inventory with the company. Economic Order Quantity reduces the high cost of inventory storage.

The economic order quantity, or EOQ, is the optimal number of units a business should purchase when replenishing inventory while minimizing inventory costs that could eat into profit margins. As mentioned above, your safety stock is the amount of product you keep on hand, above what you believe will sell, to ensure you don’t run out between orders. For example, a popular item that was once what is accounts receivable what kind of account is accounts receivable in constant demand may fall out of style, or a business may need to ensure they have more Halloween costumes available for purchase in October.

Constant Delivery Time

The holding costs of the company per year are $5,000 and its ordering cost is $2,000 per year. Examples of holding costs include insurance and property tax, rent, deterioration, maintenance fees, storage space, shrinkage, obsolescence, and others. Using EOC helps the company stay ahead of demands and not run out of stocks. Stocks are available in abundance and deadlines are easily met when you use the Economic Order Quantity to perfection. This results in keeping long-term customers and clients, and lower customer acquisition costs (CAC). Economic Order Quantity is valuable to both small and big business owners.

EOQ is part of inventory management that ensures the inventory is always monitored. It ensures that a company orders a fixed quantity every time the inventory attains a specific reorder point. Based on the provided information, we have calculated that you should order 1,581 units to keep your inventory costs at their lowest. As inventory costs are optimized, you may consider changes in the product’s price policy. The demand for your product throughout the year is 500,000 units. On average, you have to pay $4 for keeping one notepad in your inventory.

The EOQ is the optimal amount of inventory to minimize inventory holding costs, and ordering costs. Ordering costs include things like processing fees, shipping charges, and staff time spent placing orders. Holding costs, on the other hand, encompass storage fees, insurance, product deterioration, and the opportunity cost of capital tied up in inventory. Holding cost is the total costs a company incurs to hold inventory in a warehouse or store.

For the EOQ to work, demand should be measurably consistent year by year. Getting the sales numbers from January and assuming that you will experience the same demand for the rest of the year might lead to inventory shortages or overages down the line. Why should you, the savvy ecommerce entrepreneur, care about EOQ? It’s not just about math equations; it’s about unlocking the potential for significant cost savings and optimal inventory management. The EOQ tells you how much of a product you should order, so you can easily use that number when manually creating purchase orders in your POS system, if it has that functionality. But there are also ways to use the EOQ with reorder points to streamline your inventory management workflow.

Holding Cost

EOQ also assumes a fixed purchase price, but suppliers often offer quantity discounts. Sometimes, these discounts can make a larger order quantity more cost-effective than the EOQ. For this item, we end up placing an order every 2 months, compared to every 18 days in the first example.This contrast highlights how demand and holding costs influence order frequency. The Total Cost curve, the sum of Holding and Ordering Costs, reaches its minimum where the two costs are equal.

• After identifying the optimal number of products, the company can minimize the costs of buying, delivering, and storing products.
• Instead of focusing on ordering costs or carrying costs individually, a company should attempt to reduce the sum of these costs.
• For accurate values, I recommend talking to your Finance Department, as they’ll have precise data on these cost factors.
• Getting the sales numbers from January and assuming that you will experience the same demand for the rest of the year might lead to inventory shortages or overages down the line.
• The advantage of a large order quantity is reduced ordering costs per unit.
• Let us understand the concept of economic order quantity equation with the help of a suitable example.
• Here’s a simple, step-by-step guide to help you integrate EOQ into your inventory planning process effectively.

There are several ways business advisor job description to optimize inventory using the EOQ model, discussed in detail below. The total Holding Costs for our Nike shoes are $2.85, which represents 9.5% of the purchase price. Providing the aforementioned services allows Logos to offer inclusive logistics solutions to our customers from start to finish, nationwide. By applying EOQ concepts, farmers can manage their inputs more efficiently, potentially leading to cost savings and improved crop yields.

Read the next sections to find out more about what is EOQ, how to use the simple EOQ formula, and what the EOQ meaning is to improve your inventory management. For multiple products, adjustments or different inventory management techniques may be required. Ordering is the cost of placing an order to the supplier for inventory. The annual quantity calculates the number of orders demanded divided by the volume per order. Malakooti (2013)10 has introduced the multi-criteria EOQ models where the criteria could be minimizing the total cost, Order quantity (inventory), and Shortages.

When this balance is off, it can lead to a range of cost-related issues that impact everything from cash flow to customer satisfaction. The EOQ model also includes the term total cost (TC), which, as shown in figure below, is a non-variable value. In general, TC should be understood as the sum of fixed costs of order placement (order placement cost) and variable costs of inventory storage (inventory storage cost). Whatever the size of your organisation, having effective inventory management will help reduce costs and stockholding. Keeping safety stock on hand is a good idea, as it can help you avoid unhappy customers if you run out of the item they want due to supplier delays, unexpected demand, or an inaccurate inventory forecast.

The Economic Order Quantity is a set point designed to help companies minimize the cost of ordering and holding inventory. The cost of ordering inventory falls with the increase in ordering volume due to purchasing on economies of scale. However, as the size of inventory grows, the cost of holding the inventory rises. EOQ is the exact point that minimizes both of these inversely related costs. EOQ isn’t a set-it-and-forget-it kind of thing – it needs a little TLC now and then!