What is Economic Order Quantity EOQ? Definition, Formula, Examples, Importance

If a company is constantly placing small orders to maintain a specific inventory level, the ordering costs are higher, and there is a need for additional storage space. It’s an important figure for any business trying to minimise overspending while meeting demand, and especially for any business looking to reduce its overall inventory costs. The EOQ equation is usually used to set the reorder point within your inventory management workflows.

EOQ Calculation in Excel: Step-by-Step Guide

Ltd. wants to know EOQ as it is a tool to calculate the volume and frequency of orders required to minimize the cost per order. The sum of the two costs gives an annual total cost of an order. Ordering is the cost of placing an order to the supplier for inventory. what is the difference between adjusting entries and correcting entries The annual quantity calculates the number of orders demanded divided by the volume per order. The process of calculating EOQ can be either computerised of manual.

Formula and Calculation of Economic Order Quantity

EOQ is widely applicable but may not be suitable for businesses with highly variable demand, short product life cycles, or complex supply chains. In such cases, alternative inventory management methods may be more effective. Economic Order Quantity (EOQ) is the order size that minimizes the sum of ordering and holding costs related to raw materials or merchandise inventories.

Key takeaways

• This is important, as holding inventory on-site results in additional real estate costs, security fees, utility bills, insurance premiums, and other related costs.
• Additionally, the holding cost per smartphone per year is $5 (holding cost per unit per year, H).
• Stocks are available in abundance and deadlines are easily met when you use the Economic Order Quantity to perfection.
• Inventory management is a balancing act between having enough stock to meet demand and avoiding the costs that come with holding too much of it.
• But you can always make tweaks to the inputs based on your own situation.
• Economic Order Quantity (EOQ) is a classic inventory management formula used to determine the ideal order quantity that minimizes the total cost of ordering and holding inventory.
• The EOQ formula assumes stable costs across transportation and storage.

These tools continuously analyze your inventory movements, update demand patterns in real time, and automatically suggest or apply EOQ adjustments based on the most recent data. In a real-world retail setup, you’re dealing with hundreds (if not thousands) of SKUs, each with varying demand rates, supplier costs, and holding expenses. Manually updating EOQ values based on shifting inputs is time-consuming and prone to errors. And if you’re still using spreadsheets to do it, chances are you’re either overstocking to play it safe—or constantly reacting to out-of-stock issues.

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The ideal order size to minimize costs and meet customer demand is slightly more than 28 pairs of jeans. quickbooks vs excel for small business A more complex portion of the EOQ formula provides the reorder point. One of the biggest mistakes businesses make is treating EOQ like a “set it and forget it” formula.

Why do businesses use the EOQ?

EOQ is a formula for calculating minimum purchase order requirements for a business, whereas MOQ is the minimum purchase order for the seller. EOQ can be a very useful formula, but it also has its limitations. The reason for this is that it makes assumptions about stock levels and demand throughout the year.

Economic order quantity is important because it helps companies manage their inventory efficiently. Without inventory management techniques such as these, companies will tend to hold too much inventory during periods of low demand while also holding too little inventory during periods of high demand. For many companies, inventory is its largest asset other than its human resources, and these businesses must carry sufficient inventory to meet the needs of customers. If EOQ can help minimize the level of inventory, the cash savings can be used for some other business purpose or investment. Integrating EOQ into a broader demand forecasting strategy allows businesses to stay agile—balancing cost-efficiency with responsiveness.

The EOQ calculation will ensure enough product is on hand, which can lead to increased sales. Calculating EOQ for each item in stock will help you determine the right amount that meets demand, with fewer products in your store. This is important, as holding inventory on-site results in additional real estate costs, security fees, utility bills, insurance premiums, and other related costs. EOQ itself does not directly account for lead time, but businesses must ensure they reorder when inventory levels reach the reorder point, calculated considering lead time to prevent stockouts. The concept of economic order quantity equation helps in cash flow management by bringing a balance in the quantity of orders and funds required for the same. It is necessary to strike this balance because inventory is extremely essential because it is the main asset that helps to run the business.

• We believe everyone should be able to make financial decisions with confidence.
• For accurate values, I recommend talking to your Finance Department, as they’ll have precise data on these cost factors.
• What this can mean is that the seller’s MOQ is higher than a buyer’s EOQ and the order can’t be placed.
• Calculating the EOQ on each item will give you the optimal reorder point, meaning when the item’s inventory falls to a specific number, it’s time to reorder.
• Businesses should update their EOQ calculations regularly to keep up with changes in demand, costs, and other factors that might affect inventory management.
• In the below-given figure, we have shown the calculation of the EOQ for a manufacturing company.

But it is important to keep it in proper quantity which is neither too high nor too low. 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 EOQ formula is the square root of (2 x 1,000 pairs x $2 order cost) / ($5 holding cost) or 28.3 with rounding.

How Digital Tools Can Automate EOQ Calculations

It prevents the need to spend more and the risk of running low on stocks while demand persists. 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. Let’s take the case of a mid-sized fashion retailer with multiple store locations and a centralized warehouse.

In practice, you can have fixed costs in a warehouse (rent, depreciation of machines) but also variable costs like workforce or electricity. EOQ assumes constant demand, but in reality, demand fluctuates due to seasonality or unpredictable peaks. If demand isn’t steady, ordering the same quantity every 18 days, for example, can lead to overstocking during low-demand periods or stockouts during high-demand peaks.

Lead time demand means the amount of demand you anticipate the product will have between now and when the delivery will arrive to replenish your stock. Safety stock is the amount of extra inventory you keep on hand to ensure you don’t run out. Your reorder point is a predetermined level of inventory a business is comfortable reaching before it’s time to place a new order. This number is different for every item, as each item will have a unique EOQ. It can be difficult to forecast the exact optimal number of stock to have on hand at your business and may result in cautious calculations that cause you to order smaller amounts.

Also, as the number of orders decreases, the ordering cost decreases but the holding cost increases. The Economic Order Quantity (EOQ) is the point at which the sum of the ordering and holding costs is at the profitability ratio and company evaluation the minimum level. 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.