Markdown

EOQ

EOQ is the Acronym for Economic Order Quantity

A fundamental formula in inventory management, Economic Order Quantity (EOQ) determines the optimal order size that minimizes a company’s total inventory costs. It balances the trade-off between the cost of ordering products and the cost of holding (storing) them. The model was developed by Ford W. Harris in 1913, but the consultant R. H. Wilson applied it extensively, and he and K. Andler are given credit for their in-depth analysis.

The Core Problem: The "Sawtooth" Balance

Every business faces a dilemma when restocking:

  • If you order too much: You save on shipping and admin fees, but your warehouse costs (rent, insurance, spoilage) skyrocket.
  • If you order too little: Your storage costs stay low, but you pay more in frequent shipping fees and risk running out of stock (stockouts).

The EOQ Formula

To find the sweet spot where total cost is at its absolute minimum, we use the following mathematical model:

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Where:

  • D (Annual Demand): How many units you sell or use per year.
  • S (Order Cost): The fixed cost per order (shipping, handling, processing).
  • H (Holding Cost): The cost to hold one unit in inventory for a year (storage, insurance, opportunity cost).

Key Assumptions of the Model

For the standard EOQ formula to be accurate, certain conditions must be met:

  • Constant Demand: You sell the same amount of product every day/month.
  • Fixed Lead Time: You know exactly how long it takes for a shipment to arrive.
  • No Quantity Discounts: The price per unit stays the same regardless of how many you buy (unless using an Advanced EOQ model).
  • Instantaneous Replenishment: The entire order arrives at once.

Why EOQ Matters for Your Business

Calculating your EOQ helps improve cash flow and operational efficiency by:

  • Minimizing Waste: Reducing the amount of capital tied up in sitting inventory.
  • Optimizing Warehouse Space: Ensuring you aren't paying for extra square footage to store unneeded bulk.
  • Data-Driven Purchasing: Moving away from gut feeling orders toward mathematically backed procurement.

EOQ vs. ROP (Reorder Point)

While EOQ tells you how much to order, the Reorder Point (ROP) tells you when to order. Most businesses use them together:

  • When my stock hits 50 units (ROP), I will order exactly 400 more (EOQ).