Managing inventory isn’t just about keeping shelves stocked—it’s about striking the right balance between supply and cost. Order too much, and you’re stuck with excess stock eating up warehouse space. Order too little, and you risk stockouts that disappoint customers and delay fulfillment. For many retailers and supply chain teams, this balancing act becomes a major cost driver. If your business doesn’t see a lot of fluctuation, the EOQ formula can be easily implemented in a manual inventory tracking system. Otherwise, you may need to upgrade to an inventory management software to ensure you’re ordering the right number of products at the right time.
But there are several additional benefits to using the economic order quantity model and ordering the ideal amount of inventory at the ideal time. As we know, EOQ base on the assumption of fixed demand, which is not the case in real life. The warehouse, production, and purchasing department need to work closely. They must take action immediately if the demand different from planning. The supplier also has the minimum quantity per order, which depends on other factors such as the nature of material, size and safety. Placing order outside of supplier standard may result in additional cost, and it may not possible.
By determining a reorder point, the business avoids running out of inventory and can continue to fill customer orders. If the company runs out of inventory, there is a shortage cost, which is the revenue lost because the company has insufficient inventory to fill an order. An inventory shortage may also mean the company loses the customer or the client will order less in the future. The formula can help a company control the amount of cash tied up in the inventory balance. 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.
Example of How to Use Economic Order Quantity (EOQ)
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. 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. Applying EOQ calculations to your inventory management can be a huge cost saver. But it also involves doing a fair bit of math—making it a relatively difficult model to implement if you’re tracking your inventory manually. Martin loves entrepreneurship and has helped what is price variance dozens of entrepreneurs by validating the business idea, finding scalable customer acquisition channels, and building a data-driven organization.
Economic Order Quantity: EOQ Formula + Excel Guide
This intersection represents the EOQ, the optimal order quantity that minimizes total costs. Integrating EOQ into a broader demand forecasting strategy allows businesses to stay agile—balancing cost-efficiency with responsiveness. When supported by analytics and automation, EOQ becomes more than a static formula; it becomes part of a proactive approach to inventory optimization. This is especially impactful when combined with strategic workforce planning in warehouse management, ensuring your people, processes, and stock levels are all aligned for maximum efficiency. 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. When this balance is off, it can lead to a range of cost-related issues that impact everything from cash flow to customer satisfaction.
Ordering Cost
It’s especially useful for businesses that manage recurring purchases of the same products and are looking to optimize how much they order and when. In simpler terms, it’s the sweet spot where you order just enough inventory to meet demand without overstocking or understocking. Economic order quantity (EOQ) is the order size that minimizes the sum of ordering and holding costs related to raw materials or merchandise inventories. In other words, it is the optimal inventory size that should be ordered with the supplier to minimize the total annual inventory cost of the business.
With a Dynamic EOQ, you calculate the EOQ with forecasted demand, tailoring order frequency to demand cycles. This keeps your inventory aligned with real demand—avoiding overstock during slow periods and stockouts when demand spikes. Calculating the cost of placing an order (Transaction Costs ) can be tricky because it’s more than a single expense. It includes all the fixed costs of each process involved in placing every order. The more accurate your inputs, the more valuable your EOQ result will be. Using real-time inventory data or integrating this process with your inventory software can help make sure you’re planning with precision—not guesswork.
Cut Costs and Streamline Your Supply Chain Process
Economic Order Quantity (EOC) is the quantity required to avoid running out of stocks. Malakooti (2013)10 has introduced the multi-criteria EOQ models where the criteria could be minimizing the total cost, Order quantity (inventory), and Shortages. The application of tabular approach is not common as it is more time consuming as compared to formula approach. Moreover, in some situations, it provides only an estimate of economic order quantity and is therefore not as accurate as the formula approach.
It is the most common method that company use to optimize the inventory cost to the minimum level. The economic order quantity model is most commonly used to determine the costs of inventory in a given time period. Holding cost is the total costs a company incurs to hold inventory in a warehouse or store. The total holding costs depend on the size of the order placed for inventory.
- It gives the best results concerning inventory which leads to better and long-lasting patronage.
- Now that we have a basic understanding of what EOQ is, let’s explore why it’s so crucial in logistics.
- On the one hand, you want to take advantage of economies of scale (a.k.a. the savings available when you order a higher quantity of items at once).
- A more complex portion of the EOQ formula provides the reorder point.
- Businesses can use the EOQ to figure out the ideal number of units they should order in order to keep costs low.
The EOQ is designed to help companies or small businesses strategize to minimize their overall costs by learning the trends of their production. After identifying the optimal number of products, the company can minimize the costs of buying, delivering, and storing products. 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).
Transaction costs
Economic Order Quantity represents the optimal amount of inventory a company should order each cycle to keep costs as low as possible. This approach gives you a clearer, more precise look at your costs and lets you make data-backed decisions on where to cut down. In this example, we’re using a percentage of the item’s purchase price for simplicity.
Examples of holding costs include insurance and property tax, rent, deterioration, maintenance fees, storage space, shrinkage, obsolescence, and others. Economic Order Quantity is valuable to both small and big business owners. It assists managers in taking decisions on the number of times they make orders on a particular item, how often they reorder to get low possible costs and how much inventory they have. This key metric can also be defined as the most economical and cost-effective inventory quantity level a company, industry, or small business orders for the sake of reducing the cost of inventory. It addresses the issue of how much stock a business should order at a time. EOQ is part of inventory management that ensures the inventory is always monitored.
The economic order quantity is computed by both manufacturing companies and merchandising companies. EOQ takes into account the timing of reordering, the cost incurred to place an order, and the cost to store merchandise. 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. By finding the optimal balance between these two costs, companies can minimize their total inventory-related expenses. The advantages of EOQ include reduced ordering and holding costs, while disadvantages include assumptions that may not match real-life conditions. The Economic 6 best payment gateways for small businesses Order Quantity (EOQ) formula isn’t just a theoretical concept—it’s a practical tool that businesses across industries use to streamline their inventory management.
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In addition, you can always see what you have in stock and you can calculate your material requirements for upcoming orders. Economic order quantity is not the best option if you are looking to exploit quantity discounts. For example, the EOQ might say that the ideal order quantity is 175 units but the supplier is offering a significant discount for quantities over 200. It’s a practical tool for any business looking to optimize inventory costs. By integrating these best practices into your EOQ strategy, you can streamline your operations, reduce unnecessary expenses, and ensure that your inventory aligns with business goals.
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. Having too much inventory results in higher costs that take away from profits due to the cost of maintaining inventory and sometimes having to discard old inventory. Having too little inventory means a company is losing out on sales by not meeting demand.
- 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.
- The formula can help a company control the amount of cash tied up in the inventory balance.
- The two most significant inventory management costs are ordering costs and carrying costs.
- Regular audits, leveraging inventory management software, and staying aware of market dynamics can significantly reduce errors and improve outcomes.
- Before implementing Economic Order Quantity (EOQ), the team relied on manual ordering based on gut feeling and past experience.
- For example, the EOQ might say that the ideal order quantity is 175 units but the supplier is offering a significant discount for quantities over 200.
- Schedule regular reviews of your EOQ calculations to ensure they reflect current realities.
But you can always make bank draft definition tweaks to the inputs based on your own situation. We believe everyone should be able to make financial decisions with confidence. Yes, especially with inventory software that makes calculations quick and adapts to changing conditions. No more guessing or relying on “gut feelings.” With EOQ, you rely on data, which means better decision-making and fewer surprises. To reach the optimal order quantity, the two parts of this formula (C x Q / 2 and S x D / Q) should be equal. We can reduce this risk by having a fixed contract with the suppliers and issuing the penalty to them if delivery time does not meet.
Economic order quantity is a supply chain management technique used to determine the optimal lot size per order. This is done in order to avoid stockouts and overstocking, thereby balancing inventory costs and opportunity costs. EOQ applies only when demand for a product is constant over a period of time (such as a year) and each new order is delivered in full when inventory reaches zero. There is a fixed cost for each order placed, regardless of the quantity of items ordered; an order is assumed to contain only one type of inventory item. There is also a cost for each unit held in storage, commonly known as holding cost, sometimes expressed as a percentage of the purchase cost of the item.
