What Is Economic Order Quantity (EOQ)?

Economic order quantity (EOQ) is the ideal quantity of units a company should purchase to meet demand while minimizing 澳洲幸运5官方开奖结果体彩网:inventory costs such as holding costs, shortage costs, and order costs. This production-scheduling model 𒈔was developed in 1913 by Ford W. Harris and has been refined over time. The economic order quantity form🔯ula assumes that demand, ordering, and holding costs all remain constant.

Formula for Economic Order Quantity (EOQ)

The formula for EOQ is:

$\begin{aligned} &Q = \sqrt{ \frac{2DS}{H} }\\ &\textbf{where:}\\ &Q=\text{EOQ units}\\ &D=\text{Demand in units (typically on an annual basis)}\\ &S=\text{Order cost (per purchase order)}\\ &H=\text{Holding costs (per unit, per year)}\\ \end{aligned}$​Q=H2DS​​where:Q=EOQ unitsD=Demand&n𒊎bsp;in units (typically on an annual basis)S=Order cost&nb😼sp;(per purchase&n𝓀bsp;order)H=Hꦬolding costs (per unit, per year)​

What Economic Order Quantity (EOQ) Can Tell You

The goal of the EOQ formula is to identify the optimal number of product units to order. If achieved, a company can minimize its costs for buying, delivering, and storing units. The EOQ formula can be modified to determine different production levels or order intervals, and corporations with large 澳洲幸运5官方开奖结果体彩网:supply chains and high variable costs use an alg✅orithm in their computer 𒅌software to determine EOQ.

EOQ is an important 澳洲幸运5官方开奖结果体彩网:cash flow tool. The formula can help a company control the amount of cashꦚ tied up in the inventory balance.

For many companies, inventory is its largest asset other than its human resources, and the💧se businesses must carry sufficient inventory to meet the needs of customers. If EOQ can help minimize the level of inventory, the cash savings can be used for some other business purpose or investment.

The EOQ formula 澳洲幸运5官方开奖结果体彩网:determines the inventor📖y reorder point of a company. When inventory falls to a certain level, the EOQ formula, if applied to business processesಌ, triggers the need to place an order for more units.

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 t𒉰he company loses the customer or the client will order less in the future.

Example of How to Use Economic ওOrder Quantity (꧋EOQ)

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 ꦓorders to maintain a specific inventory level, the ordering costs are higher, and there is a need for additional storage space.

Assume, for example, that a retail clothing shop carries a line of men’s jeans, and the shop sells 1,000 pairs of jeans each year. It costs the company $5 per year to hold a pair 💟of jeans in inventory, and the fixed cost to place an order is $2.

The EOQ formula is the square root of (2 x 1,000 pairs x $2 order cost) / ($5 holding cost) or 28.3 with rounding. The ideal order size to minimize costs and meet customer demand is slightly more than 28 pairs of jeans. A more complex portion of the EOQ formula provide📖s the reorder point.

Limitations of Economic Order Quantity (EOQ)

The EOQ for🍎mula assumes that consumer demand is constant. The calculation also assumes that both ordering and holding costs ♛remain constant.

This fact makes it difficult or impossible for the formula to account for business events such as changing consumer demand, seasonal changes in inventory cost👍s, lost sales revenue due to inventory shortages, or purchase discounts a company might realize for buying inventory in larger quantities.🦋

The Bottom Line

Managing inventory is a key component of success for a company. 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 in💟ventories efficiently.