It is always good practice to reduce your costs as much as possible, to maximize your profits. Read the next sections to find more about what is EOQ, how to use the simple EOQ formula and what the EOQ meaning is to improve your inventory management.
The EOQ meaning
Products being ordered in, not immediately being used, and then stored in a warehouse costs you money. On the other hand if you run out of the product, you may lose clients. To maximise profit, you need to maintain a perfectly balanced inventory with as few costs as possible which is not easy - but EOQ is here to help!
The EOQ model helps us to calculate what the order size should be to reduce your inventory costs. The model assumes that there are costs related to the ordering and holding of the products in the inventory, and the EOQ calculator helps you keep these costs to the lowest they can be.
Thanks to the EOQ formula, you can easily predict your orders and keep your inventory optimally managed. The value of economic order quantity tell you the number of units you should order to minimize your holding and ordering costs.
You may think of EOQ not only as a useful model to manage your inventory, but also as a way to manage your company's cash flow. There are many companies for which inventory costs significantly impact their balance sheet.
How to calculate EOQ?
The economic order quantity formula requires a bunch of data to work correctly:
- Yearly demand for the product which EOQ is calculated;
- Holding cost, which is the cost of keeping one unit of the product in the inventory;
- Order cost, which is how much you have to pay to order the product;
- Ordering and holding costs, as well as demand, which should remain constant during the year; and
- That's it - you have gathered all the data for the EOQ formula!
In the next section, you may input your data into the economic order quantity formula, or follow the example provided below.
The EOQ formula
Follow the economic order quantity formula below to calculate your optimized order:
EOQ = (2 * Demand * Order costs / Holding costs)0.5
Let's go through an example to learn more about the EOQ meaning. Imagine that you have a company that sells notepads. The demand for your product throughout the year is 500,000 units. Each order costs you $10. On average, you have to pay $4 for keeping one notepad in your inventory.
EOQ = (2 * 500,000 * $10 / $4)0.5
EOQ = (2,500,000)0.5
EOQ = 1,581.14 units
Based on the provided information, we have calculated that you should order 1,581 units to keep your inventory costs their lowest. As inventory costs are optimized, you may consider changes in the product's price policy.