Demand
Order Cost
Holding Cost
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In day-to-day business, managers and retailers often face difficulty in determining the exact number of items they should order to refill their stock of a particular item. Order quantity is not a minor issue — ordering too many items increases your holding cost, and ordering too little can result in an out-of-stock situation. Both are unfavorable for any business and should be avoided to keep your business operations viable
The Economic Order Quantity (EOQ) formula helps to avoid these mis-stocking situations. It calculates the ideal number of units you should order, such that the cost involved is minimal and number of units is optimal.
The following formula is used to calculate the EOQ:
Economic Order Quantity:
√(2 x S x D)/H
The Annual demand is the number of units that you sell annually. If actual units are not available, then you can use expected sales figure based on your sales trend.
This refers to the costs that are involved with an order but cannot be directly associated with the purchase cost.
This refers to all the costs that are involved in storing or handling the items in your store or warehouse. Usually, holding costs are fixed in nature.
Once these three are calculated, the following formula is used to calculate the EOQ:
Economic Order Quantity: √(2 x S x D)/H
The Annual demand is the number of units that you sell annually. If actual units are not available, then you can use expected sales figure based on your sales trend.
The following table will give you a better idea about what the other factors are that can have an impact on demand and your business operations:
This refers to the costs that are involved with an order but cannot be directly associated with the purchase cost.
This refers to all the costs that are involved in storing or handling the items in your store or warehouse. Usually, holding costs are fixed in nature.
The EOQ assumes that the demand for your products will remain constant throughout the year. It does not consider seasonal changes or fluctuations in demand.
The EOQ assumes that holding and ordering cost remain constant, which may not always be the case. An increase or decrease in your transport charges, a change in the salary of your employees, or rising rent for your warehouse can all impact your costs and affect the calculations that go into the EOQ.
The EOQ also fails to factor in vendor discounts. Sometimes it makes sense for a retailer to buy a product in bulk from the vendor to get a discount. In such cases, buying items in fewer installments can actually optimize the retailer's costs despite what the EOQ predicts.
Economic Order Quantity may not consider all the factors that affect each business, but it is still a powerful tool to help an entrepreneur or manager to make more calculated decisions. What makes the EOQ a compelling tool is that it is dynamic and can be revisited from time to time as your business grows. If there's a change in any of your inventory costs, you can always tweak the formula and generate a new EOQ to suit the current conditions.
Calculating the EOQ for your business helps you find a good balance for your order and inventory costs, which are easy to overlook in day-to-day business. The EOQ formula shouldn't be taken as gospel, but it's a useful tool for informed, effective inventory control.
Inventory control
Warehouse Management
Multichannel Selling
Order Management
Order Fulfillment
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