Economic Order Quantity

What is Economic Order Quantity (EOQ)? EOQ stands for Economic Order Quantity. I understand that. What does it do? Excellent question. EOQ provides the most economic lots to purchase an item/part. Really! How does EOQ do that? Good question. EOQ uses the Annual Movement, Purchasing Order Cost, and the Holding Cost per Unit to determine the most cost-efficient batch quantity to order.

Economic Order Quantity formula

With the equation SQRT( [2DO]/H), we try to determine our perfect order quantity based on a mathematical formula. Let’s look at the variables.

Annual Unit (D)emand is the Annual Unit Demand, use the Trailing 12 Months (T12M).

(O)order Cost per Order per Purchase is all the costs of creating and processing an order with a supplier.

(H)olding Cost per Unit = Sum of (Employee Salaries (other than Direct Labor) + Storage Fees + Opportunity Costs + Depreciation Costs) / Total Value of Annual Inventory.

The costs are on a Trailing 12 Months (T12M) basis.

From here, you will apply the formula to your data. As an example:

Annual Unit (D)emand = 100,000

(O)rder Cost per Order = $50

(H)olding Cost per Unit = 10¢

EOQ formula is: 

SQRT( [2DO]/H)

=SQRT( [2*100,000*50])/0.10)

=SQRT( [10,000,000]/0.10)

=SQRT( 100,000,000)

= 10,000

The Annual Unit (D)emand divided by the EOQ of 10,000, which means there will be 10 orders during the year of 10,000 units.

As the Order Cost per Order increases, the Units to Order per Order will increase.

As the (H)olding Cost per Unit increases, the Units to Order per Order will decrease.

Downside to EOQ

The Economic Order Quantity calculation is a match formula. This is the problem with EOQ. EOQ does not account for seasonality, supplier minimum order quantity, supplier lag time, shipping challenges, storage issues, personnel issues, spoilage, or any other hiccup in the system.

We would like to hear from you. Please leave your comments below. Did you find this blog post helpful? Why do you use the Economic Order Quantity (EOQ) within your Inventory/Purchasing function? If yes, let us know how you use it and its effectiveness. If you don’t use it, let us know why not. Thank you for your input.

Thank you! Have a great day, and be safe!