What is Economic Order

Quantity (EOQ) in Inventory

Management?
By:Hadleigh Reid
Category:Inventory
Last Updated: May 26, 2022
Economic order quantity (EOQ) is a term for the ideal quantity a
company should purchase to minimize its inventory costs, like
shortage or carrying costs. The overall goal of economic order
quantity is to decrease spending; its formula is used to identify the
greatest number of units needed (per order) to reduce buying.
One of the primary gains of the EOQ model is customized
recommendations for your particular company. At times, EOQ may
suggest investing in a larger order to take advantage of discount bulk
buying and to cut down on total costs associated with multiple
shipments.

Calculating Economic Order Quantity (EOQ)

Calculating economic order quantity requires some math that might
seem complicated at first, however once you get the variables from
your inventory management system, it’s easy to plug in the
numbers and calculate EOQ. When you use a robust ERP, these
calculations may all be handled for you, including order costs like
inventory ordering costs, holding costs and stockout costs.

Three Variables Used to Calculate EOQ

There are several variations of the formula used to calculate EOQ.
One popular EOQ formula is based on these variables, also called
inputs:
1. Annual Demand in units
2. Order cost
3. Holding costs (per unit, per year)

Economic Order Quantity (EOQ) Formula

Factors that affect Economic Order Quantity
 Reorder point
It is the time when you need to reorder another set of stock or
replenish the existing stock. EOQ always assumes that you
order the same quantity at each reorder point.
 Purchase order lead time
This is the time period from placing the order until the
ordering is delivered. EOQ assumes that the lead time is
understood.
 Purchasing cost per unit
The cost per unit never changes, over the period of time,
even though the quantity of the order is changed. EOQ
always assumes that you pay the same amount per product,
every time.
  Stockouts
There are no chances for stockouts. You have to always
maintain enough inventory to avoid stockout costs. This
clearly states that you always have to strictly monitor your
customer demand along with your inventory levels, carefully.
 Quality costs
EOQ never focuses on the quality costs, rather the carrying
costs.
 Demand
It’s about how much the customer wants the product for a
specific time period.
 Relevant ordering cost
The cost per purchase order.
 Relevant carrying cost
The cost involved in the entire maintenance and carrying the
stock, for the specific period.

Benefits of Utilizing Economic Order Quantity

The main benefit of using EOQ is improved profitability. Here’s a list
of benefits that all add up to savings and improvements for your
business:
 Improved Order Fulfillment: When you need a certain item

or something for a customer order, optimal EOQ ensures the

product is on hand, allowing you to get the order out on time
and keep the customer happy. This should improve the
customer experience and may lead to increased sales.
 Less Waste: More optimized order schedules should cut

down on obsolete inventory, particularly for businesses that

hold perishable inventories that can result in dead stock.
  Lower Storage Costs: When your ordering matches your
demand, you should have less products to store. This can
lower real estate, utility, security, insurance and other related
costs.
 Quantity Discounts: Planning and timing your orders well
allows you to take advantage of the best bulk order or
quantity discounts offered by your vendors.

Why is EOQ Important?

Holding inventory can be one of the most expensive aspects
of ecommerce fulfillment. It’s expensive to manufacture or procure
and it is expensive to keep in stock. Whether it is raw materials, work
in process (WIP) or finished goods, companies can use EOQ as an
efficient ordering guideline to prevent shortages while not maintaining
excess inventories. Economic order quantity is often one of
many inventory forecasting techniques available in an inventory
control or ERP solution. Other techniques include reorder points,
period of supply, etc.

How to Use EOQ to Improve Inventory

Management
When you calculate EOQ, you know the ideal order size to maximize
profits for your organization. It prevents guessing, and there’s less
cause for concern about overordering or running out of stock. You can
follow the data and the numbers to make the best long-term decision
for your business’s inventory needs.
If you run a large business, a business that requires expensive
inventory, or a business with high inventory holding costs, EOQ could
have a significant impact on your business, improving operational
efficiency, cash flow and profits for years to come.

Bottom Line
Economic order quantity might not consider all the factors that affect
business but is still a powerful tool if it sits right for you. Calculating
the economic order quantity (EOQ) for your business can help you to
analyze better, order better, and eventually have better profit margins.

https://dclcorp.com/blog/inventory/economic-order-quantity-eoq/

https://www.youtube.com/watch?
v=kDU3kOZuJJw&list=PLfY7btDOjkLoA7tLX20mw9sIUIrTfdC4m&index=4