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What is EOQ Formula (Economic Order Quantity)?

July 17, 2024

Learn how to grow your business by implementing the EOQ Formula to calculate your optimal rate of production.

Here’s What We’ll Cover:

What is EOQ (Economic Order Quantity)?

Why Use EOQ?

EOQ Formula Factors

Economic Order Quantity Formula

EOQ Formula Calculators

More About EOQ

Accounting Resources for Businesses

What is EOQ (Economic Order Quantity)?

To understand the EOQ Formula, you must first know how to define economic order quantity. Economic order quantity or EOQ is a tool used to determine the volume and frequency of orders that a business must produce in order to reach a specific level of demand, all the while keeping inventory costs low.

EOQ: The optimal volume and frequency of orders to satisfy a given quota of sales

This method significantly helps simplify production and creates a consistent and predictable pattern of sales.

With that in mind, every aspiring entrepreneur or small business owner should learn and implement this method into their sales strategy in order to have success.

Why Use EOQ?

Small businesses have costs that make a big impact.

When you’re selling a product and gaining demand, you need to backstock. You want to fulfill the number of orders you’re getting without loads of extra product, and without running out of stock–all the while, trying to keep your costs down and maintaining a level of efficiency.

An EOQ Formula will help you establish that flow.

The economic order quantity is a method designed to help businesses strategize to minimize their overall costs by learning the trends of their production. In other words, EOQ helps you plan how much product to keep in stock for the amount of sales you make– keeping you from spending more than you need to.

Using an EOC Formula can boost your business by optimizing your inventory and keeping production costs low:

Minimize Inventory Costs – Once you determine your economic order quantity, you can predict how much inventory is necessary to keep in backstock, saving you from paying extra storage costs and setup costs
Minimize ‘Stock-Outs’ – Use the EOQ formula to stay ahead of your order demands and never run out of stock
Predict Surges – Once you’ve established your EOQ and you’re utilizing the patterns in order production, you can keep track of when your order volume increases and make sure to replenish your inventory
Overall Efficiently – Knowing your optimal economic order quantity will overall keep your business running smoothly and efficiently by giving you the best insight on how much stock to order to suffice your growing demand.

EOQ Formula Factors

EOQ: The optimal volume and frequency of orders to satisfy a given quota of sales

There are many different factors and costs that play into creating an EOQ Formula:

Quantity of inventory
Consumer demand
Average shipping costs
Storage costs
Annual ordering costs
Order size/ order discounts

In order to determine EOQ formula, there are 3 key factors to determine:

Holding Cost (H)
Annual Demand (D)
Order Cost (S)

Holding Cost

Minimizing the cost of inventory you have to store and manage is a key supply chain management strategy for any retail business. How much are your storage costs for your product, per unit, per year? Determine the holding cost by adding all of your opportunity costs and divide them by the value of your annual level of inventory.

Storage + employee salary + depreciation costs / annual inventory value = Holding Cost

Annual Demand

Calculating your annual demand quantity is an important step in creating your EOQ Formula. How many orders are you getting? Look back on past years order history to determine your customer demand and predict how many sales you’ll be making in the upcoming year.

Order Cost

This is the cost of each individual order that you send out. The unit cost includes the raw material, shipping and handling and all of the expenses that went into the item- otherwise known as setup cost.

Economic Order Quantity Formula

Once you’ve determined your 3 key factors; holding cost (H), annual demand (D), and order cost (S) you will use them to establish your EOQ formula:

EOC = Square Root of [2SD] / H

Example

Let’s plug in these variables to test our formula:

You have %0.75 in holding costs per unit (H)
A demand rate of 5,000 units per year (D)
An order cost of $500 (s)

EOQ = Square root of (2)(500)(5000)/.75 = 2,582 units per order.

Your optimal order quantity is 2,582 units per order.

EOQ Formula Calculators

The EOQ formula is a helpful tool in calculating your optimal order quantity and using the formula will give you necessary insight on optimizing your inventory while keeping your holding costs down.

Want help calculating your EOQ Formula?

If you find the determinants of your EOQ formula, you can use a EOQ formula calculator to do the math for you. There are many different options online, and it helps to cross reference to make sure that the formula you choose is optimizing your inventory in the most efficient way (different formulas may plug in additional determinants).

More About EOQ

Whether just starting out in your online business, or looking to implement key production strategies for a growing brand, using EOQ formula will make calculating inventory a smoother operation, and improve your price per order costs.

Use the EOC formula from this article or plug in your determining variables into an EOC calculator and start simplifying order production for your small business.