By
Sarah Foley
The EOQ formula is an essential part of any inventory management strategy. EOQ, or economic order quantity, is a formula designed to optimize your ordering strategy and minimize costs.
Many businesses use inefficient strategies when reordering products for their business, which wastes both time and money. Using the EOQ model for inventory streamlines the process and can help you provide better service for your customers. In this article, we’ll take a look at the EOQ formula and why it’s important for your business.
What is economic order quantity (EOQ)?
The EOQ formula calculates the optimal amount of product you need to order to fulfill your demand. While it seems easy to just refill your inventory when you run out, this can actually cause problems with your supply chain later on. Using the EOQ formula can help you calculate consistent order quantities.
In its simplest form, the EOQ model is the square root of two times your setup cost and demand rate, divided by your holding costs. We will discuss each component of this formula later on in the article. You can use this formula for each individual product to determine how much product you order in each batch.
Why is economic order quantity important?
Using the EOQ formula offers a wide range of benefits for your business. Not only can it help you save money, but it also helps your business run more efficiently. Here are the benefits of using economic order quantity to calculate your order components.
Reduce your inventory cost
One of the biggest benefits of using this formula is that it reduces your inventory costs. Over-ordering comes with a lot of additional expenses. Not only are you paying for products that might not sell, but you are also paying additional storage costs for your items.
Depending on what type of products you sell, you may also have to pay costs associated with maintaining your products or correcting the damage that happens in transit. By using the EOQ formula, you can calculate the precise amount of product you need to order to prevent these additional expenses.
Lower your chances of stockouts
Stockouts can cost your company money and affect the quality of your service. Using the EOQ formula can help to prevent this. This formula dramatically reduces your chances of having a stockout, which ensures that you will be able to fulfill your customers’ orders.
It’s very important that you are able to consistently provide the products that your customers are looking for. Being able to fulfill orders can increase customer loyalty and ensure that your business has a reputation for good service.
Increase efficiency
Efficiency is very important when it comes to tracking your inventory. You shouldn’t be guessing when it comes to ordering your products – you want to make sure that you have the right amount to fulfill your customers’ needs based on your demand rate, holding costs, and other factors. The EOQ formula is a standard calculation that works for most products, which means that you can use it to save time and stress during the ordering process.
Economic order quantity terms
In order to calculate economic order quantity, there are a number of key terms that you will need to know. Here are the most important components of the EOQ formula.
Demand rate
The EOQ formula uses an annual demand rate in most cases. This is the amount of product that you sell in a given year. The EOQ formula assumes that you have consistent yearly demand. While this is the case for most products, the formula might not work for every product for this reason. You could also calculate your EOQ rate with quarterly or monthly demand to account for regular seasonal changes.
Fixed cost and variable cost
Fixed costs are costs that are standard and do not change over time. Examples of fixed costs that you may have include the rent and insurance for your storage space. Variable costs, on the other hand, are directly related to the amount of product you acquire and sell. Variable costs are often dependent on the type of product you sell and the industry you are in.
Holding cost
Your holding costs are the costs associated with storing your product. These costs are variable, so they can change over time depending on the amount of product you have. These costs include any storage fees you pay to your warehouse, as well as any insurance you have taken out on your product.
Ordering cost
The ordering cost is the amount of money you spend to place and receive orders. This does not include the cost of the product but does include the associated cost of shipping. It also includes the labor costs associated with placing and receiving the order.
Unit cost
The unit cost is the amount of money it costs to receive one unit wholesale. Unit costs can change over time as a result of external factors.
Shortage cost
Shortages can be very expensive. The shortage cost represents all of the additional expenses associated with product shortages. This includes any revenue from lost sales as well as expedited shipping costs associated with placing last-minute orders. The shortage cost could include the loss of future sales, as shortages often cause customers to seek out products elsewhere.
How to calculate economic order quantity
The economic order quantity calculation is fairly simple. It is:
EOQ = √(2 x demand rate x cost per order)/holding cost
The EOQ will tell you when to reorder your product. If your EOQ is 50, that means you need to reorder when you get down to 50 products left in stock.
This formula won’t work for every product, but it will work in a wide variety of situations to prevent stockouts and unexpected costs. If your demand or holding costs are not stable throughout the year, the EOQ formula may not work for you.
The EOQ formula also does not consider vendor discounts or promotions. There are times when you may want to order earlier or later to take advantage of bulk pricing, holiday promotions, or other discounts.
Economic Order Quantity: Final Thoughts
The economic order quantity formula is excellent for inventory forecasting. It can help you conduct your shipments more efficiently, save money, and provide better service for your customers. If you need assistance with your inventory management, consider working with a third-party logistics firm like Print Bind Ship.
Contact us today to learn more about our services and how we can help!