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Economic Order Quantity & Economic Order Quantity Formula

By
Joshua
on
Tuesday, November 17, 2020
Table of Contents

Order, order in the warehouse!

When choosing what inventory models to implement for your business, economic order quantity should always be considered. It can help mitigate rising costs, streamline your warehouse operations, and put more money in your pockets.

Keep reading to find out how economic order quantity works, what benefits it brings, and how you can implement it in your own business.

EOQ: What is Economic Order Quantity?

Economic order quantity (EOQ) is a production-scheduling method of inventory control that has been used since the early 1900s. This method is built around finding a balance between the amount you sell and the amount you spend on inventory management.

Economic Order Quantity Definition

Economic order quantity is the ideal amount of product a company should purchase to minimize inventory costs. Essentially, it is the amount of product you should order to meet demand without having to store any excess inventory.

Optimal Quantity

The optimal quantity is the exact amount of inventory you should order and keep on hand to meet demand. Finding your optimal order quantity for a product is the goal of calculating its EOQ. However, this number is very difficult to achieve as any slight variance in demand, cost, or price will throw your numbers off.

Importance of Economic Order Quantity

Managing economic order quantity is an important part of the job for an inventory control manager. It can help avoid issues like excess stock or dead stock and keep avoidable losses to a minimum. It also helps you establish goals for your inventory KPIs, informs inventory forecasting decisions, and helps increase the company's sales and revenue.

Advantages of Economic Order Quantity

Utilizing EOQ for your business can provide many benefits. Here are just a few.

  • Minimize costs. All warehouse inventory managers know that storage costs can quickly rise if inventory isn't controlled. By only ordering the amount needed to fulfill customer demand, these costs can be kept very low.
  • Adapts to your business. Many inventory methods are only viable for certain types of business. EOQ utilizes only your own numbers, so it can benefit any business that uses it.

Economic Order Quantity Problems

Though there are definitely positive aspects of calculating EOQ, there are also a few drawbacks that you need to be aware of.

  • The math is complicated. You'll see the formula used for EOQ calculations below, and it's safe to say it isn't the easiest to use. Luckily, there are many ways to automate the process and tools to help.
  • It's based on assumptions. There are a number of assumptions that are required to calculate EOQ. This means any aspect of your business that doesn't match will throw off the numbers and you won't get the optimal quantity. Still, the numbers you find are very helpful for inventory planning.

EOQ Formula: Economic Order Quantity Formula

Calculating economic order quantity requires you first find a few metrics regarding demand and costs. These are the annual demand for the product in units, the cost per order, and the annual holding cost per unit. Once you've collected this data, it's as easy as plugging them into the formula below.

How to Calculate EOQ

Uncovering the economic order quantity for a product can be done using a slightly complicated formula.

Here's that formula:

EOQ = √ (2 x Demand x Order Cost / Holding Cost)

Economic Order Quantity Formula and Example

If any of that seems confusing to you, let's clear it up a bit with an example.

Let's say you are a wholesale supplier for the food industry. You have a particular product you're looking to optimize, in this case cans of creamed corn. The first thing you do is look at your historical data regarding creamed corn.

After poring through your data, you calculate that you normally sell an average of 2,500 cans each year. You also look through your purchase orders and inventory costs to calculate that each shipment of 100 cans of corn costs $75. And you find that storage of each can costs you $20 per year.

With these variables in hand, you can now calculate your optimal EOQ for cans of creamed corn. Let's plug them in.

EOQ = √ (2 x Demand x Order Cost / Holding Cost)
EOQ = √ (2 x 2500 x 75 / 20)
EOQ = 136.9 or 137 cans

We discover that the optimal order size is 137 cans of creamed corn. Pair this with calculating the optimal reorder point, and you can maximize the profit you make from cans of corn.

EOQ Calculator: Economic Order Quantity Calculator

Using the formula above is great if you're calculating the EOQ for a single product, but what if you have thousands of SKUs?

That's where an EOQ calculator comes in handy. There are a few ways you can do this. First, there are options online where you can manually input data to find your EOQ. Second, a calculator may be built into your inventory management software if you use one. Lastly, you can use an Excel sheet and import product data.

Economic Order Quantity Excel

EOQ calculations can be done quickly with far less room for error by using an Excel spreadsheet. That’s why we put together a simple economic order quantity spreadsheet for you. Just download the EOQ template, replace our sample data with your own, and begin optimizing your inventory orders!

EOQ Model: Economic Order Quantity Model

The EOQ model is used by many industries, but is most prevalent in businesses that operate a just in time inventory system. These systems are built to minimize inventory that is held on location and require constant contact with suppliers.

There are a few assumptions of economic order quantity you need to understand if your business is going to use it.

  1. The rate of demand is constant.
  2. Ordering costs are consistent.
  3. Unit price is constant.
  4. Lead time is constant.
  5. There is no safety stock.

These assumptions are necessary as the formula will not be accurate if any of the numbers involved fluctuate.

Difference between Economic Order Quantity and Reorder Quantity

Though you may come across both terms in your journey through inventory control, economic order quantity and reorder quantity are not the same. Both numbers are used to determine the best amount of inventory to order but are calculated in different ways. Reorder quantity is a formula used by ecommerce businesses and is based only on sales and lead time.

Order Up!

Calculating the economic order quantity for your products can help you make the most out of your warehouse space, minimize costs, and increase revenue. All it requires is a focus on inventory tracking, the accrual of actionable data, and properly performed inventory auditing.