When it comes to inventory management, knowing what you’ve got, where it is, and how much of it you have on hand is absolutely essential. This knowledge is key to practicing proper inventory control, the balancing act of stocking just enough inventory to meet customer demand without sacrificing profitability. Here’s an overview of economic order quantity, why it matters, and how to calculate EOQ for your small business.
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What is economic order quantity?
Economic order quantity, or EOQ, reveals precisely how much of a product a company should order to meet customer demand while minimizing holding and ordering costs. Economic order quantity (EOQ) helps your business practice more effective inventory control.
Economic order quantity aims to prevent businesses from tying up too much cash in inventory assets. After all, inventory alone is expensive enough. Add to that costs to order, receive and maintain inventory, and your business can really spend a pretty penny stocking items it just doesn’t need.
When used properly, EOQ helps your business stock the perfect amount of inventory—enough to meet the demands of your customers. The rest of your cash can be saved for a rainy day, or injected into other areas of business, like sales, marketing, or human resources.
You may also hear about Minimum Order Quantity (MOQ) when researching EOQ— but be assured, they are quite different. MOQ is the minimum order amount set by a supplier or retailer, while EOQ refers to how much of a product a company should order to meet customer demand while minimizing holding and ordering costs. You will likely use both MOQ and EOQ in your overall inventory management strategy.
Economic Order Quantity Formula
What is the formula for calculating economic order quantity? It’s simpler than you might think. The formula for calculating EOQ is: √(2DS / H)
There are multiple pieces of information you’ll need from your inventory records before you learn how to calculate economic order quantity. Gather the following information in order to utilize the formula:
- Set-up cost (S) — This refers to the per-order cost of ordering the inventory (ex: delivery, shipping, labor, etc).
- Demand (annually), in units (D) —The amount of inventory your company sells annually.
- Holding costs (H) — The additional cost of holding a piece of inventory annually (ex: storage costs, depreciation, etc).
Annual fixed costs are how much you pay suppliers for your product over the course of a year. Demand refers to how many units of a given product your customers have asked for in a 12-month period. Finally, carrying costs refer to how much money your business spends carrying one unit of a given product throughout one year.
The economic order quantity formula assumes that demand and costs remain constant. Consequently, EOQ is best applied to products in your inventory that are equally desirable throughout the year. These products should also cost the same amount to order, receive and maintain, no matter the month.
EOQ can be confusing when applied to products consumers only want occasionally or under certain circumstances. This model works best for businesses for which demand is consistent and easily forecasted. For more seasonal-based businesses, or businesses for which demand has fluctuated, EOQ will be minimally useful. Nonetheless, it’s still good to have a general ballpark understanding of how much inventory you should have, subject to fluctuations and seasonality.
Inventory Management Software for Better Inventory Control
If you want to practice air-tight inventory control, you’ll need to pinpoint just how little inventory you can order without fear of running out. Inventory management software can help you track every item you stock and reveal how your business uses (or doesn’t use!) inventory over time.
There are many varieties of inventory management software on the market today, from ultra-expensive programs to intuitive inventory apps you can access from your smartphone.
Sortly, a best-selling inventory app, helps businesses of all shapes and sizes practice inventory control. The app offers a forever-free plan and two affordable monthly plans, which you can try free for two weeks. Key features include in-app barcode/QR code scanning, low stock alerts, flexible folders and tags, customizable reports and the ability to visualize and track items across multiple locations.
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