Economic Order Quantity (EOQ)

Maintaining the inventory and supply chain is a hell of a rigid system. As a seller, you have to fight with:

• Warehousing
• Logistics
• Order fulfillment
• Holding costs
• Inventory stockouts
• Incurring costs on the inventory storage for a long time.

All such cases depress the sellers and ask them to develop the proper plan.

Good news! We have an Economic Order Quantity.

It helps predict future costs and elevates trust in the overall inventory. Sellers can order the optimal number of products and resell them. Are you ready to devise new success pathways and enjoy a flawless business opportunity?

Listen up! Today, we will discuss the EOQ and dig deep into the factors that influence economic order quantity.

Chapter 1: EOQ Basic Idea

 What is Economic Order Quantity (EOQ)?

Economic Order Quantity refers to the optimal number of products companies require to refill the stocks. It calculates the data for the number of products to order. The calculation aims to optimize the inventory stocks for the whole supply chain system.

 Why is EOQ so important?

Various things help us understand why EOQ can be a game-changing case. These include:

• Cost optimization. Sellers order only a limited number of products required. It helps them save on extra costs.
• Inventory optimization. Optimal stocks help suffice consumers’ needs. So, customer satisfaction is near.
• Better efficiency. Optimal orders with streamlined shipping maintain the flow of inventory better.

 

Chapter 2: Why Should You Calculate the EOQ?

If you are thinking of the EOQ, it is the best idea ever if implemented correctly. There are a few reasons why you should consider the EOQ.

 Cost optimization

Cost optimization is one of the most significant benefits of the EOQ calculation. It saves the cost in multiple ways. For example:

• Sellers order limited items. It shrinks the inventory prices and helps manage business better.
• Inventory storage costs decrease exponentially. That is why sellers save more costs.

Such cost optimization allows better business over there.

 Improved inventory turnover

Since you are managing the inventory with the right approach, it is no longer a big deal to devise a plan to manage your products. You order the required number of items that quickly sell.

Such an approach optimizes the inventory levels. Helps replenish the orders on time. And enjoy better inventory efficiency.

Reduction of stockouts and overstock situations

Stockouts or overstock are toxic things for a business. This is mainly eliminated with the EOQ formula. Sellers get the calculated number of stocks that sell. There is no overstocking, leading to elevated inventory expenses or stockout situations and decreased consumer satisfaction.

Enhancing overall supply chain efficiency

Supply Chain relies on product sales and shipping. What if you sell and ship products on time? That leads to an elevated flow of inventory through the whole supply chain.

Guess the results? You’ll get better inventory management. Overall, supply chain efficiency will skyrocket with this approach.

Quantity discounts

There comes a season when the product demands are high. In that case, sellers find the sweet spots to order inventory in bulk and enjoy the volume discounts.

Sometimes, calculation tells the high number of products. In that case, sellers also order more products and enjoy discounts.

 

Chapter 3: Factors Affecting EOQ

Various cost types affect the EOQ. You can recognize the following types.

 Holding costs

Holding costs refers to the overall expenses of inventory management. It deals with inventory storage, insurance, and depreciation, including handling costs.

Higher holding costs can affect EOQ and urge sellers to make fewer orders and save more money.

 Ordering costs

Ordering costs are the set of prices including the ordering and processing. It calculates the overall prices, including the handling during transit and shipping.

Elevated ordering costs cause the EOQ to minimize the number of products ordered and adjust it in the given budget.

 Demand rate

The demand rate is the interest of consumers and the period in which inventory sells. A higher demand rate causes EOQ to order more products. At the same time, a slow demand is poisonous and causes EOQ to decrease its costs.

Lead time

Lead time is the overall time required to produce the products. It is the time from receiving orders till the production.

Longer lead times let EOQ forecast more products to avoid stockouts.

Stockout costs

How many consumers were going to order? How many are on the waiting list? All such cases talk about the stockout costs. Sellers can handle the stockouts and order products to meet their inventory stock requirements.

Chapter 4: The EOQ Formula Explained

 Basic EOQ formula

Understanding the EOQ can untangle the mystery. The calculation is super easy. Take a look at the formula:

 EOQ= (2DS)/H

 Breakdown of formula components

Let’s break down each component of the formula.

 Annual demand

D in the formula represents the annual demands. It refers to the overall products needed annually. If the yearly demands are high, EOQ can be higher.

 Ordering cost

The costs involved in product ordering range from the logistics to handling fees. If the order costs are higher, EOQ jumps up and urges bulk orders to be made with reduced numbers.

 Holding cost

The cost of maintaining inventory comes under the holding costs. It comes with:

• Warehousing prices
• Insurance costs
• Depreciation if any

 Step-by-step guide to calculating EOQ

The calculation of the EOQ is quite simple.

• Step 1: Research and know the annual demands, ordering costs, and holding costs.
• Step 2: Assess the costs and input the data into the formula.
• Step 3: Calculate the EOQ values and make your next step accordingly.

 EOQ formula variations (e.g., production quantity model)

Three types of models are variants of the EOQ. These include:

• Production Quantity Model (EPQ). Are you producing and selling inventory under your manufacturing plants? You can use the EOQ model to calculate the consumption and production rate for all the inventory production.
• Quantity discount model. It helps make bulk orders and saves inventory prices with their ordering costs.
• The Backorder modeladjusts the EOQ. It is applicable when the delayed delivery has to meet the overall demands.

 

Chapter 5. Holding Costs in Detail

Definition of holding cost

Holding costs is the sum of all prices required to manage the inventory. From warehouse to insurance, it comes with all prices.

 Components of holding cost

• Warehousing costs. Finding the warehouses and paying for the costs. These include rent, utilities, and staff for managing products.
• Insurance costsare costs involved in protecting inventory against theft, loss, or damage.
• Depreciationrefers to the loss in value over time if the product loses quality or gets spoiled, especially food items.
• Opportunity Costis the potential profit loss in maintaining the inventory. Sellers could have fetched profits from other businesses.

How to calculate holding cost

Calculate the holding costs with the following:

Holding Cost = (Storage Costs + Employee Salaries + Opportunity Costs + Depreciation Costs) / Total Value of Annual Inventory

Calculate each cost and then apply it to the formula.

 Importance of accurate holding cost estimation

Understanding the accurate holding costs is beneficial as:

• Sellers can determine how much of their budget they have.
• It can specify products to order.
• Cost and inventory optimization is quite imminent.
• There is no longer an overordering of the products.

 

Chapter 6. Ordering Costs Explained

 Definition of ordering cost

Ordering cost is the price invested in finding the suppliers and making orders. All costs come under the ordering cost category, from ordering to reception and inspection.

 Components of ordering cost

• Administrative costsare all the time and resources used to deal with the supplier. It includes the purchasing and invoicing costs.
• Transportation costsinclude all the costs invested in bringing orders to the warehouse or home.
• Inspection and Receivingare the optional but crucial components. Sellers hire the inspection experts to assess the inventory.

 How to calculate ordering cost

The calculation formula for the order costs includes: 

Administrative costs + logistical expenses + inspection costs / Annual number of orders

Sellers can efficiently calculate the total ordering costs annually and make their steps accurate toward the business deals.

Impact of ordering cost on EOQ

Do you have a high ordering cost?

Consider:

• High ordering costsincrease the EOQ. As a result, sellers have to make few orders but in bulk to reduce expenses.
• Low order costsallow the sellers to make multiple small orders without causing cost burdens.

 

Chapter 7. Practical Application of EOQ

A step-by-step guide to implementing EOQ

When it comes to the implementation, you have to consider the following steps.

• Step 1: Gather Data

First of all, get the data for demand (D), ordering costs (S), and holding costs (H). Remember to validate the current costs and ensure accuracy.

• Step 2: Calculate EOQ

Calculate the EOQ by adding the values in the EOQ formula.

EOQ= (2DS)/H

It helps determine the number of products to order and the time during which you should order.

• Step 3: Integrate EOQ into inventory

Integrate and apply the EOQ. For example, if the EOQ orders 50 orders to avoid the ordering costs, go for it. Similarly, you can understand our examples in detail.

• Step 4: Establish Reorder Points

Set time and threshold for the orders. Always ensure the orders are on time and triggered when a specific inventory level reaches.

EOQ calculation examples for different industries

Various industries have different calculation systems. Let’s apply our EOQ formula in multiple systems and understand how it works.

• Retail Industry

Consider a small retail store. Suppose it sells 500 products annually. Take an estimated holding costs. Suppose it costs $2 per annum while the ordering costs $30.

EOQ= (2∗500∗30)/2

EOQ= 15,000/2

EOQ= 7,500

Final EOQ ≈87 units

Retailers must order 87 units daily to reduce the ordering costs and optimize business.

• Manufacturing industry

Now, take the example of the manufacturing industry. A manufacturing plant orders 10K units annually.

Here is the data:

Ordering costs = $100 per order

Holding costs = $5 per year

EOQ=(2∗10,000∗100)/5​

EOQ= 2,000,000/5

EOQ​=400,000

Final EOQ​= 632 units

The manufacturer has to order at least 632 units every time to avoid extra costs and optimize the products.

• eCommerce industry

The eCommerce industry has to come up with the EOQ for cost optimization. You can take the example of a retailer selling 2k products annually.

The data is:

Ordering costs = $50

Holding costs $1 per annum

EOQ= (2∗2,000∗50)/1

EOQ = 200,000

EOQ = 447 units

Retailers must order at least 447 units per order to optimize the business costs.

How to interpret EOQ results

With the calculation, EOQ helps define the total number of products per order. If there is:

• Higher EOQ. It means more products should be ordered each time. Why? It is because of cost optimization and competitive pricing.
• Lower EOQ. Reduced EOQ urges less number of orders to meet the demands.

Such an approach can define and optimize the products required to order each time.

Adjusting EOQ for real-world scenarios

EOQ is a practical guide, but sometimes, you must modify it to adjust it accordingly. Consider the adjustments in the following cases.

• Fluctuating demands

Demands don’t remain the same the whole year. You can order the products as per demand and adjust the EOQ.

• Variable lead times

Elevated lead times can urge EOQ to order more products. Adjust the EOQ as per the lead time variations.

• Volume discounts

Some sellers want volume discounts. They have to adjust the number of products ordered every time as per the EOQ values.

• Limited storage

In case of limited space, sellers adjust the number of orders. Instead of implementing the exact EOQ, they reduced the number of orders to occupy as much space as possible.

Chapter 8. EOQ vs. Other Inventory Models

Just-In-Time (JIT) inventory

JIT models ask for the product orders only when the products are needed. The purpose is to keep the inventory levels low and avoid the holding costs.

It is different from the EOQ as it orders only when products are needed. At the same time, the EOQ talks about the inventory assessment based on annual demands and orders.

Materials Requirements Planning (MRP)

The MRP model is more applicable in the manufacturing industry. It talks about ordering raw materials to produce inventory and minimize delays.

Difference include:

• MRP applies only to manufacturing, while EOQ applies to all industries.
• MRP talks about the current materials, not the annual ones, as in the EOQ.

Vendor Managed Inventory (VMI)

Vendor-managed inventory model integrates the warehouse with the suppliers. The ordering occurs when the products drop below a specific level. The supplier is responsible for the inventory levels, not the seller.

Differences include:

• VMI gives more control to the supplier and stocks left, not the seller, as in EOQ.
• EOQ is more straightforward in inventory management than the VMI.
• VMI deals when the products drop below a specific level, unlike the EOQ, which equally works for overstock and understock.

Criteria	EOQ	Just-In-Time (JIT)	Materials Requirements Planning (MRP)	Vendor Managed Inventory (VMI)
Primary Goal	Optimize order quantity by balancing ordering and holding costs	Minimize inventory by receiving goods only when needed	Ensure material availability for production schedules	Shift inventory management responsibility to the vendor
Inventory Levels	Medium (balance between holding and ordering costs)	Very low (inventory received just in time for use)	Varies (inventory based on production needs)	Varies (vendor manages stock levels)
Demand Stability	Works best with stable and predictable demand	Works best with stable demand and reliable suppliers	Varies based on production forecasts	Varies, but vendor adjusts based on customer needs
Complexity	Simple calculation of optimal order quantity	High reliance on supply chain efficiency	High complexity, especially in manufacturing	Depends on vendor capabilities and relationship
Suitability for Manufacturing	Can be used for simple manufacturing processes	Ideal for lean manufacturing	Specifically designed for manufacturing	Less commonly used in manufacturing
Supplier Relationship	Moderate dependence on suppliers	High dependence on reliable suppliers	Varies, but often moderate reliance on suppliers	Strong vendor partnership required
Inventory Holding Costs	Balances holding and ordering costs	Very low holding costs	Varies depending on production requirements	Reduced for the customer (managed by vendor)
Stockout Risk	Low, if EOQ is calculated and followed properly	Higher risk if supply chain disruptions occur	Moderate, based on accuracy of production schedules	Low, as vendor monitors and restocks inventory
Ordering Frequency	Periodic orders based on EOQ calculations	Frequent, small orders as needed	Orders scheduled based on production needs	Automated ordering managed by vendor
Customization	Flexible, can be adjusted based on cost changes	Less flexible, highly dependent on supplier schedules	Can handle complex, multi-level production	Limited customization, relies on vendor’s system
Best For	Businesses with predictable demand and a need for cost optimization	Lean, efficient operations with reliable suppliers	Complex manufacturing with detailed production schedules	Businesses looking to outsource inventory management to suppliers

When to use EOQ vs. other models

Each model has a specific case for deploying it under certain conditions. For example, EOQ is suitable when:

• Conditions are stable.
• You have accurate data for your sales with the current and past annual demands.
• Fluctuations are less.
• There are no limits on inventory management.

Criteria	EOQ (Economic Order Quantity)	Just-In-Time (JIT)	Materials Requirements Planning (MRP)	Vendor Managed Inventory (VMI)
Business Type	Retail, wholesale, or manufacturing with stable demand	Lean manufacturing, assembly operations	Manufacturing with complex production processes	Retailers, distributors, or manufacturers with strong vendor relationships
Demand Stability	Predictable and stable demand	Stable, consistent demand	Fluctuating demand based on production schedules	Varies, vendor adjusts to demand fluctuations
Supply Chain Requirements	Moderate reliance on suppliers	Requires highly reliable, responsive suppliers	Requires integration with suppliers for raw materials	Requires a close partnership with vendors
Inventory Holding Costs	Balance between holding and ordering costs	Minimal inventory holding costs	Varies, inventory levels depend on production needs	Reduced for the business (managed by vendor)
Lead Time Flexibility	Moderate lead time	Short lead times, immediate delivery	Can accommodate longer lead times	Managed by the vendor, replenished as needed
Production Environment	Can be used for simpler manufacturing processes	Ideal for lean, low-inventory operations	Suitable for complex, multi-level production	Not typically used in production, but in distribution and retail
Supplier Relationship	Moderate reliance on suppliers	Requires tight coordination with suppliers	Moderate to high reliance on multiple suppliers	Strong, long-term relationship with the vendor
Cost Sensitivity	Used to optimize holding and ordering costs	Focus on reducing total costs through efficiency	Focus on minimizing stockouts and ensuring production flow	Costs are often managed by the vendor
Risk of Stockouts	Low if EOQ is followed	Higher risk due to dependency on supplier performance	Low to moderate, depending on forecast accuracy	Low, vendor is responsible for managing stockouts
Industry Examples	Retailers managing regular stock levels	Automotive, electronics, and other lean production sectors	Aerospace, automotive, electronics manufacturing	Retailers like supermarkets and pharmacies, and distributors

 

 

Chapter 9. EOQ Model Variations

The EOQ model comes with multiple variations. Consider the following cases.

 Production Quantity Model (EPQ)

The production quantity model refers to the inventory of in-house production. If the seller is a direct factory, this model is quite applicable. Instead of sudden replenishment, inventory replacement occurs gradually.

It is suitable for:

• Factories are selling products directly and maintaining the products.
• Manufacturers are looking to reduce production costs.

Quantity Discount Model

If the sellers want to grab the bulk discounts, they can use the quantity discount models. It tells whether bulk ordering is more beneficial or not.

It is suitable for:

• The sellers are looking for bulk orders with gradual inventory replacement.
• The sole purpose is to save costs.

 Backorder Model

The backorder model is another EOQ variation that only applies in a few cases. Consumers are ready to wait when sellers no longer have the inventory in stock.

It is suitable in the following cases:

• Sellers offer customized products to meet consumers’ requirements.
• Consumers can wait for the products to grab and receive them at home.

Multi-Item EOQ Model

Multi-item EOQ model talks about a wide range of products. This model considers the warehousing facilities and the limited product space.

It is suitable for:

• Wholesalers and distributors are dealing with multiple products.
• Retailers sell a wide range of items in their retail stores.

 

Chapter 10. EOQ and Technology

EOQ calculators and software tools

Each tool has its significance in managing and calculating the orders.

The popular EOQ calculators include:

• TradeGecko
• NetSuite
• SAP Inventory Management

You can input the following values:

• Annual Demands
• Holding costs
• Ordering costs

These tools automatically verify and calculate the EOQ.

Using such tools can assist in the accuracy of orderings and proper management of the products.

 Integrating EOQ into inventory management systems

• Inventory management tools

Various inventory management tools trace the number of products left. They can help calculate the prices. Some robust cloud-based inventory management tools include:

• Fishbowl
• Zoho Inventory
• Unleashed
• Integration of EOQ

Integration of EOQ can come with the following:

• Price tracking. Sellers can track the orders through these tools. They can understand the value of products and the number of products required to order.
• Automated order triggering. Keep the threshold of inventory. If you add 50 units as a threshold, the automated orders will be triggered when the product count is below 50.
• Inventory optimization. Overstocking or stockouts are not possible. EOQ integration allows the optimal number of warehouse products and effective cost management.

Advanced analytics and EOQ optimization

Analytics can devise new methods of success for the inventory. For example:

• Predictive analysis. AI integration can drive the data in real-time. It describes the previous year’s sales and the relevant conditions. Also, seasonal change prediction is possible. As a result, EOQ adjustment occurs, leading to better and optimized products.
• AI and Machine Learning magics. Integrating AI and machine learning can help you understand patterns and alert you to future demands. Sellers will readjust the EOQ. Consider the past performances and overstocking or stockouts. Order new products from suppliers. Get sales and demands based on the requirements.
• Optimization algorithms. Specific algorithms can trace the changes and decide better. They keep an eye on demand variability, lead time uncertainty, and fluctuating costs.

Chapter 11: FAQs

• Does EOQ differ from other inventory management models?

EOQ is quite different from the other management models such as Just in time inventory or ABC model. For example, the EOQ urges the sellers to balance their products. However, different methods, such as Just in Time, only urge the minimization of the number of products and the keeping of crucial items. Therefore, EOQ stays at a better end than the other models.

• Is EOQ valid for all types of products?

EOQ is quite good at the green products that sell the whole year. It helps forecast and order the required number of items. However, this method might fail if the inventory fluctuations and demands are mind-boggling. So, the EOQ model can be applied to stable and non-perishable products.

• What happens if the actual demand is different from the forecasted demand?

If the actual demand is higher than the forecasted, prepare for stockouts. Overstocking occurs if the actual market is less while the forecast is higher. As a forecaster, you must consider all these costs.

• How frequently should you recalculate the EOQ?

Set a time period for the calculation of the EOQ. Usually, a monthly or annual forecast period is a good idea. However, consider the current demands, holding costs, and ordering costs. All the factors influence the EOQ.

Conclusion

EOQ calculation can be super straightforward, but the problem is when you don’t have a plan to order. Ordering high quantities can cause a problem with overstocking and increased costs.

However, you can connect with sourcing companies such as JustChinaIt and have your inventory refilled. We can alert you about the deceased number of products or overstocking as a one-stop solution. Fetch the following services from our experts.

• Sourceproducts at wholesale prices.
• Warehousethem and keep their stocks optimal.
• Consolidate
• Shipthem to your destination location.

Talk to our experts for the best.