Understanding Economic Order Quantity (EOQ): Overview, Calculation, Benefits, and More

Effective inventory management can significantly enhance sales for many businesses. This is particularly beneficial for companies that rely on buying and holding inventory. For these entities, calculating their economic order quantity (EOQ) is crucial.

It allows them to order items in the perfect quantity, ensuring they meet market demand while avoiding overstocking. Keep scrolling to learn more about EOQ, its calculation formula, its importance in logistics management, and more.      

What is Economic Order Quantity: An Overview

Economic order quantity (EOQ) is a calculation that helps businesses find their ideal order size. It allows them to have enough inventory to satisfy customers’ requirements without allocating too much capital to inventory and storage.   

This metric can be used by all companies that buy and hold inventory for resale, internal use, manufacturing, or any other purpose. 

The formula for Calculating Economic Order Quantity 

Here is the formula for calculating EOQ:

EOQ = √ [2DS/H]

Now, as you can see, the economic order quantity formula consists of 3 variables. They are:

• D = Demand in units (yearly)
• S = Order cost
• H = Holding costs (per unit, annual)

Step-by-Step Guide to Calculating EOQ

Following are the steps you can follow to calculate economic order quantity using the above-mentioned formula:

• Step 1: Calculate the company’s annual demand in units. 
• Step 2: Determine the order cost (incremental cost to process and order one unit in inventory). 
• Step 3: Calculate the holding cost (incremental cost to hold one unit in the company’s inventory).
• Step 4: Multiply the demand in units by 2. 
• Step 5: Multiply the result with the order cost. 
• Step 6: Divide the result with the holding cost. 
• Step 7: Calculate the result’s square root in order to determine the EOQ. 

Understanding the Importance of EOQ in Logistics

EOQ enables businesses to determine the ideal order size for every item they purchase. Thus, when it comes to logistics, it serves as a key metric which helps them maintain operational sustainability. 

This is because ordering too much inventory will significantly increase their storage costs, reducing resources for other core business activities like R&D, marketing, etc., that can help cut down operating costs or increase sales. 

Moreover, determining the right economic order quantity will enable companies to avoid holding too much stock during times of low demand and too little stock during times of high demand, thus avoiding supply chain disruptions.  

Also, it can help businesses improve their operational stability, profitability and cash flow.     

Key Factors to Consider in Calculating EOQ

Following are some of the key factors that businesses must consider when calculating EOQ:

• Annual Demand: When calculating economic order quantity, companies must determine the annual demand (in units) for their products. This refers to the total number of units the business sells within a year.   
• Setup Costs: Setup costs are the expenses incurred when ordering inventory. They include costs associated with packaging, handling, shipping and delivery. 
• Holding Costs: Holding costs refer to the expenses associated with storing inventory on hand. They encompass logistics costs, warehousing, material handling costs, insurance expenses, depreciation and inventory write-offs. 

Benefits of Implementing EOQ in Logistics Management

Here are some of the advantages of implementing EOQ in logistics management:

• Lower Holding Costs: When the order quantity matches the customer demand, businesses have fewer products to store. This effectively lowers warehousing, insurance, security, and other related expenses.  
• Less Over-Ordering and Waste: Accurately calculating the economic order quantity helps avoid over-ordering, which usually consumes too much cash in inventory. Moreover, it helps cut down on obsolete inventory, especially in case of perishable items, which can become dead stock. 
• Quantity Discounts: By planning and timing orders, companies can benefit from the bulk order discounts offered by vendors.  
• Enhanced Order Fulfilment: Optimal EOQ calculation ensures that there are always enough products in the inventory to meet customer demand, resulting in timely order fulfilment and a better customer experience. 

However, to optimally manage the inventory order quantity, businesses also need a reliable logistics partner which can provide flexible solutions based on the EOQ. 

Porter Enterprise can be an excellent choice in this regard. 

By leveraging EOQ in collaboration with Porter, businesses can strategically order vehicles, ensuring an optimal fleet size based on the amount of inventory they need to transport. This helps optimise fleet utilisation, minimising excess inventory and associated costs, thereby enhancing operational efficiency and resource utilisation.

Get in touch with Porter today and learn how our services can streamline your business’s logistics operations!

Common Mistakes to Avoid in EOQ Calculation

Listed below are some of the common mistakes that businesses must avoid during EOQ calculation:

• Leveraging Obsolete Data and Outdated Systems: Businesses often end up using outdated or low-quality data when calculating economic order quantity. This usually happens when they use outdated spreadsheets or manually driven systems which can have incomplete data and thus miss out on potential savings.   
• Utilising EOQ at the Time of Business Growth: The EOQ formula assumes a relatively flat annual demand for a product. Now, when businesses are in their growth phase, the order size tends to change frequently. Using EOQ under such circumstances can make companies under-order, which can lead to potential inventory shortages.  
• Under-Ordering: As the economic order quantity formula presumes a flat annual demand, it often generates smaller order sizes. Thus, businesses that are new to using EOQ might end up under-ordering.    
• Not Considering Seasonal Changes in Customer Demand: Several products have increased demand during specific seasons. However, as EOQ assumes a flat annual demand, it will fail to provide an accurate order quantity for seasonal businesses.  

Best Practices for Implementing EOQ

Here are some of the best practices for implementing EOQ:

• Using cloud-based ERPs or inventory management systems for accurate data management.
• Identifying primary supply chain costs.
• Taking into account factors like changing customer demand and seasonal variations. 
• Avoiding EOQ calculation during growth phases. 
• Regularly recalculating EOQ, especially during times of changes in product demand or ordering costs. 

Now that you understand EOQ and its importance for your business, you can calculate it appropriately to determine the right order quantity. 

You can leave the optimization of fleet utilisation to Porter Enterprise, which will provide you with the right vehicles according to your transportation requirements. 

Rely on Porter Enterprise to avail the optimum fleet capacity as per your business’s EOQ!       

Frequently Asked Questions About EOQ