Economic Order Quantity EOQ: Definition, Formula, and Guide

In this example, we’re using a percentage of the item’s purchase price for simplicity. For accurate values, I recommend talking to your Finance Department, as they’ll have precise data on these cost factors. By applying EOQ principles, the restaurant can reduce food waste, ensure ingredient freshness, and keep costs under control. This insights and his love for researching SaaS products enables him to provide in-depth, fact-based software reviews to enable software buyers make better decisions. The EOQ assumes the lowest level at which stock can be reduced to is zero. Faults and malfunctions tend to occur in machines, warehouses, materials, etc which may alter the normal functioning of the inventory and slow down the flow of demands.

For correctly calculating EOQ, you must have accurate data available regarding demand, ordering cost, and holding cost. You must also have an inventory management system in place that provides you with the correct data regarding your inventory levels. This means you should order 283 phone cases at a time to minimize your total inventory costs. Customers are much more likely to return to a business am i still responsible for paying a debt if i receive a 1099 that is reliable, with products consistently available.

• Madis is an experienced content writer and translator with a deep interest in manufacturing and inventory management.
• The formula is such that it will automatically trigger the requirement to place further order immediately to avoid shock shortage, else it will lead to loss of revenue and customer base.
• By finding the EOQ, you can achieve a sweet spot where you order enough to avoid stockouts but not so much that your holding costs skyrocket.
• By precisely calculating your optimal order quantity, you ensure you have enough product on hand to meet demand consistently.
• Economic Order Quantity is valuable to both small and big business owners.

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. Using the EOQ for inventory planning can help you meet demand while maintaining a reasonable inventory balance.

What is Economic Order Quantity (EOQ)?

It helps businesses cut costs, manage inventory better, keep customers happy, and use resources wisely. With EOQ, businesses can avoid running out of stock or having too much inventory sitting around, which means happier customers and more money in the bank. 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.

The EOQ Formula

The quantity can be determined using any particular software or through the use of mathematical formula and help in reduction cash blockage due to unnecessary production or purchase. 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. Economic order quantity helps ensure companies manage their inventories efficiently. 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.

The Assumption that Demand is Constant

Using real-time inventory data or integrating finance and accounting outsourcing this process with your inventory software can help make sure you’re planning with precision—not guesswork. There are, however, much more accurate formulas for calculating safety stock. Businesses can use the EOQ to figure out the ideal number of units they should order in order to keep costs low. We believe everyone should be able to make financial decisions with confidence. Sandra Habiger is a Chartered Professional Accountant with a Bachelor’s Degree in Business Administration from the University of Washington.

What is the Economic Order Quantity (EOQ or Wilson Formula)?

There are so many online Economic Order Quantity (EOQ) calculators you can use to calculate EOQ for your company. They include Zoho Inventory EOQ Calculator, QuickBooks EOQ Calculator, and Omni Calculator.Omni Calculator is the best EOQ formula calculator. The EOQ formula calculator allows you to input your yearly demand, order cost, and yearly cost of holding which it uses to determine your Economic Order Quantity (EOQ). In situations where the EOQ is not a whole number, it predicts the number of units you should order to minimize your holding and order costs.

Limit 1: Unstable demand

When you use the economic order quantity model can help you cut down on dead stock and obsolete or expired products. By calculating the optimal order quantity of each item, you will be more likely to sell it well before its best-by date. Any company needs to find the correct inventory ordering balance. If they have too much unsold inventory, they’re wasting usable funds and tying up cash flow in a product that’s not selling, while spending money on costs related to storage and maintenance.

How to Use Economic Order Quantity in Inventory Management to Reduce Costs

When this information is known, the following formula can be used. Economic order quantity (EOQ) is a formula used to determine the optimal order quantity that balances the cost of ordering and holding inventory. Even though ERP/MRP systems do not automatically calculate the economic order quantity for your stock keeping units, the data collection capacity of such systems could prove very small business expense tracking useful in calculating it. This model assumes that costs like ordering and holding remain constant, whereas, especially in fast-growing businesses, inventory needs may change quickly. The EOQ could potentially lead to shortages, and may not be the best way to calculate your order size if business is booming.

Setup Costs

Businesses use it as a valuable tool to make decisions about the number of inventory to order and keep, and how often to reorder to attract the lowest possible costs. 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. But it is important to keep it in proper quantity which is neither too high nor too low.

Using EOQ with reorder point and safety stock

This keeps your inventory aligned with real demand—avoiding overstock during slow periods and stockouts when demand spikes. To minimize holding and order costs, the furniture company should order 26 units. The Economic Order Quantity determines the inventory reorder point of a company. By doing so, the company continues to fill orders and does not run out of inventory. There is also revenue lost if the company can not fill an order due to insufficient inventory.

The quantity of stock should allow the business to meet customer demand and minimize costs at the same time. EOQ is the ideal order quantity a business should purchase to minimize total inventory costs, balancing ordering and holding expenses. Therefore, ordering approximately 894 units at a time would help minimize their total inventory costs. To make EOQ practical and actionable in a fast-moving retail environment, it should be paired with modern inventory management systems. These systems can pull real-time data, automate EOQ calculations, and adjust reorder points dynamically based on sales patterns, supplier lead times, and market trends. Besides that, ERP software automates many clerical tasks related to ordering and inventory management, which can aid in minimizing purchase costs and holding costs.

• Besides that, ERP software automates many clerical tasks related to ordering and inventory management, which can aid in minimizing purchase costs and holding costs.
• Ordering cost is inversely proportional to holding cost if the annual demand remains constant.
• 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.
• We believe everyone should be able to make financial decisions with confidence.
• Yes, EOQ can be calculated in Excel using the standard formula with demand, holding, and ordering costs.

As already mentioned, the objective of the EOQ is to determine the ideal order size in units or quantities of materials to buy to avoid stockouts and overstocking. On the flip side, overstocking is like inviting a financial monster to your warehouse party. Excess inventory levels ties up capital, eats up storage space, and increases the risk of obsolescence. The EOQ helps you strike the perfect balance, ensuring you have enough stock without becoming a hoarder. The EOQ formula can be paired with the reorder point formula, which helps a business identify when it should order more inventory. Using these calculations together can help a business avoid running out of stock for its products without carrying more inventory than it needs to.

Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business. By applying EOQ, healthcare providers can ensure they have life-saving medications on hand when needed, while minimizing waste due to expired products. There are times when the cost of estimation and calculation exceeds the savings made by buying that quantity.