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.
Economic Order Quantity Definition
Inventory turnover refers to how many times a company has sold and replaced inventory over a specific time period, typically a year. Inventory turnover is important because it reveals whether your business stocks excessive inventory, relative to what your company actually uses or sells. Optimizing your inventory turnover rate and only keeping what you need in stock helps your business stay efficient and profitable.
Inventory turnover ratio is the ratio between sales or usage and current inventory in stock. For example, if you sold 500 units of inventory last year and had 500 units in your warehouse, then your ratio is 1 (1:1).
Other terms for inventory turnover include inventory turns, merchandise turnover, stock turnover, stock turns, and turns.
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.
Experience the simplest inventory management software.
How inventory software can help put EOQ into practice
Sortly inventory management software makes it easy to know the right amount to re-order for every item you use. Sortly centralizes all your inventory data into an easy dashboard view so you can quickly see how much of an item you have in stock and how much you’ve used. It takes the guesswork out of calculating EOQ; you’ll already know how much to order because you’ll be able to see your usage patterns (and thus customer demand) and have accurate data about how much is already in stock across multiple locations. Best of all, you can set low stock alerts to remind you to re-order in order to perfectly calibrate your EOQ. Simply set a minimum quantity for any item in your inventory and receive a nudge from Sortly as soon as an item falls below that quantity.
Sortly is an end-to-end inventory solution that lets you organize, track, and manage your inventory—from any device, in any location. Our easy-to-use mobile app lets you and your team update inventory on the job, scan barcodes from your smartphone, set low stock alerts to remind you to re-order, and more. That means you can work more efficiently, plan for jobs better, and serve your customers to their highest satisfaction.
If your company would benefit from improved inventory management, try Sortly free for 14 days.