Economic Order Quantity
Economic order quantity (EOQ) is the ordering quantity level where ordering costs as well as carrying cost both are minimum. It aims to minimize the costs associated with the inventory. EOQ Calculator is an online aid for calculating such optimum ordering quantity to have optimum inventory carrying costs.
Formula
The formula for calculating Economic Order Quantity is the square root of two times the annual demand multiplied by ordering cost per unit and divided by carrying cost per unit. A mathematical representation of this formula is as follows:
EOQ = √(2AO/C)
Where,
A = Annual Demand
O = Ordering Cost
C = Carrying Cost
About the EOQ Calculator / Features
The user has to simply insert the following data into the calculator for quick and easy calculation:
- Annual demand
- Ordering cost
- Carrying cost
Calculator
How to Calculate using EOQ Calculator
Economic order quantity (EOQ) calculator quickly provides the result once the user inserts the following figures into the calculator:
Annual Demand
It is the estimated annual demand for a product. It is assumed to be constant.
Ordering Cost
It includes all the costs attributable to an order. Such costs may be charges of supplying goods, charges related to payment processing, etc. Ordering cost increases with the increase in the number of orders.
Carrying Cost
Carrying cost means the cost of holding inventory that remains unsold. It includes all the costs associated with storing inventory, that is, the cost of goods that get damaged or lost, insurance, storage area costs, etc.
The ordering cost and carrying cost move in opposite directions. Ordering cost increases with the increase in the number of orders, while carrying cost per unit decreases with an increase in the number of quantities left unsold.
Example of Economic Order Quantity
Suppose the monthly demand for a toy is 5,000 units, and the holding cost of this toy is $4 per unit. The cost of ordering the same is $3 per order. What is the ideal order size for ordering that toy?
The monthly demand for toys is 5,000 units.
Therefore, annual demand = 12 * 5,000 = 60,000 units
Economic Order Quantity = √ {2 * (60,000) * (3)} / 4 = 300 units
Number of orders = Annual demand / EOQ = 60,000 / 300 = 200 orders
Now let us calculate the total cost for ordering and cost of carrying at 300 units (that is, at EOQ).
Total Ordering Cost = Number of orders * Cost per order = 200 * $3 = $600
Total Carrying Cost = EOQ * carrying cost per unit / 2 = 300 * $4 / 2 = $600
Assume that there are four options available to order stock:
1: Order all 60,000 units together.
2: Place 2 order of 30,000 units.
3: Order at EOQ, i.e., 300 units.
4: Order 100 Units at a time, i.e., 600 orders.
| Ordering Quantity (Units) | Number of Orders | Ordering Cost (1) | Carrying Cost (2) | Total Cost (1)+(2) |
| 60,000 | 1 | 3 | 120,000 | 120,003 |
| 30,000 | 2 | 6 | 60,000 | 60,006 |
| 300 | 200 | 600 | 600 | 1,200 |
| 100 | 600 | 1,800 | 200 | 2,000 |
Interpretation
The above example states that the cost is the least when one orders at EOQ. Also, the ordering cost keeps increasing with the increase in the number of orders.
Cautions
EOQ is based on certain assumptions that the demand will remain the same, as well as there is no change in ordering cost and carrying cost. However, these assumptions do not work in a realistic world. The demand keeps fluctuating according to the changes in the economic life cycle. It also assumes that there is no discount available while purchasing in large quantities, which is also not correct.
And the biggest and critical drawback is that it completely ignores the fluctuation in the price of the materials. All these savings may get far outweighed even if there is a small increase in the price of materials during the year. So the management shall make decisions keeping these factors. On a stand-alone basis, the EOQ concept should be followed to optimize the inventory cost.
