WallStreetMojo

WallStreetMojo

WallStreetMojo

MENUMENU
  • Blog
  • Free Video Tutorials
  • Courses
  • All In One Bundle
  • Login
Home » Accounting Tutorials » Budgeting Tutorials » EOQ (Economic Order Quantity)

EOQ (Economic Order Quantity)

By Sayantan MukhopadhyaySayantan Mukhopadhyay | Reviewed By Dheeraj VaidyaDheeraj Vaidya, CFA, FRM

What is EOQ?

EOQ stands for economic order quantity and it helps to find a volume of production or order that the company should add with the objective of minimizing the holding cost and ordering cost.

EOQ Formula

Let us look at the critical components of EOQ and its formula –

#1 – Holding Cost

Holding cost is the cost of a holding of inventory in storage. It is the direct cost that needs to be calculated to find the best opportunity whether to store inventory or instead of it invest it somewhere else- assuming demand to be constant.

 H = i*C

Where,

  • H= Holding cost
  • i= Carrying cost
  • C= Unit cost

Here as demand is constant, inventory will decrease with usage when it reduces to zero-order placed again.

#2 – Ordering Cost

Ordering cost is the cost of placing an order to the supplier for inventory. The number of orders is calculated by the annual quantity demanded divided by volume per order.

Number of orders = D / Q

Where,

  • D = Annual quantity demanded
  • Q = Volume per order
  • Annual Ordering Cost

An annual ordering cost is the number of orders multiply by ordering costs.

Annual ordering cost = (D * S) / Q

Where,

  • S = Ordering cost

#3 – Annual Holding Cost

Annual holding cost is the sum product of volume per order and holding cost, which can be written as.

Annual Holding Cost= (Q * H) / 2

#4 – Total Cost

The sum of the two costs gives an annual total cost of an order.

By adding annual ordering cost and annual holding cost, we get below equation.-

Annual Total Cost or Total Cost = Annual ordering cost + Annual holding cost

Popular Course in this category
Sale
All in One Financial Analyst Bundle (250+ Courses, 40+ Projects)
4.9 (1,067 ratings)
250+ Courses | 40+ Projects | 1000+ Hours | Full Lifetime Access | Certificate of Completion
View Course

Annual Total Cost or Total Cost = (D * S) / Q + (Q * H) / 2

To find EOQ – Economic Order Quantity Formula, differentiate total cost by Q.

EOQ = DTC / DQ

EOQ = √ (2SD/H)

EOQ formula

Examples

You can download this EOQ Formula Excel Template here – EOQ Formula Excel Template

Example #1

Let’s take an example to calculate EOQ – Economic Order Quantity for a pen manufacturing company where the company’s annual quantity demanded is 400, holding cost is $2, and the ordering cost is $1. Now we will put these values in the above equation.

In the below-given figure, we have shown the calculation for the EOQ for a pen manufacturing company.

EOQ formula 1

So, the calculation for EOQ2 = (2*400*1)/2

EOQ formula 1.2png

Therefore ,EOQ =20.

Example #2

Let us understand this with an example. A company names Den Pvt. Ltd. wants to know EOQ as it is a tool to calculate volume and frequency of order required for minimizing the cost of per order.

In the below-given table is the data for the calculation of EOQ – Economic Order Quantity Formula for company Den Ltd.

Take the below assumption.

EOQ Example 2-1

By keeping the above values in the below tabular equation, we get total cost with a combination of different volumes.

EOQ Example 2

Through the above data, we get below the graph.

EOQ Graph - Example 2

From it, we can clearly see EOQ is 250. EOD set point where minimize the cost of inventory.

Example #3

A company manufactures steel boxes for that it needs steel to calculate the quantity required EOD needs to be calculated.

Taking below Assumptions:-

  • Ordering Cost = $10 per order
  • Annual quantity demanded = 2000 units
  • Holding cost = $1 per unit

In the below-given figure, we have shown the calculation of the EOQ for a manufacturing company.

So, the calculation for EOQ2=(2*2000*10)/1

EOQ = (40000)1/2

EOQ formula 1.6png

Therefore, EOQ = 200

Further, we will calculate holding cost, ordering cost, and the number of orders per year and combine ordering and holding costs at economic order quantity.

  • Numbers of orders per year

The below table shows the calculation of the number of orders per year.

A number of orders per year = Annual quantity demanded/ EOQ.

So, the calculation of EOQ for numbers of orders per year is =2000/200

Example 1.10png

Therefore, a number of orders per year =10

  • Ordering Cost

The below table shows the calculation of the Ordering cost.

Ordering cost = Number of orders per year * cost per order

So, the calculation of EOQ for ordering cost is = 10*10

Example 1.11png

Therefore, ordering cost = 100

  • Holding Cost

The below table shows the calculation of the Holding cost.

Holding cost = Average unit * Holding cost per unit

So, the calculation of EOQ – Economic Order Quantity Formula for holding cost is = (200/2) * 1

Example 1.12png

Therefore, holding cost = 100

  • Combine ordering and holding cost at economic order quantity

The below table shows the calculation of the combined ordering and holding cost at economic order quantity.

Ordering cost + Holding Cost

So, the calculation for combine ordering and holding cost at economic order quantity formula is = 100 + 100

Here, holding cost and ordering costs is the same, i.e., $100.

Example 1.13png

Therefore, combine ordering and holding cost at economic order quantity formula is= 200

Let’s see the table how we can derive the same.

1.14png

From this table, we also get EOQ = 200.

Relevance and Uses

  • Cash flow planning– EOQ formula is used to minimize the cost of inventory and save cash.
  • Reordering Point- This formula is used to calculate the reordering point, i.e., point at which one gets a trigger to order inventory.
  • It helps the company to reduce waste.
  • It helps to minimize storage and holding costs.

Recommended Articles

This has been a guide to Economic Order Quantity (EOQ) and its definition. Here we learn the formula to calculate economic order quantity using practical examples and downloadable excel template. You can learn more about financial analysis from the following articles –

  • COGM
  • Ending Inventory Calculation
  • Economic Factors Examples
  • Quantity Demanded Definition
  • Fixed Budget vs Flexible Budget
0 Shares
Share
Tweet
Share
Primary Sidebar
Footer
COMPANY
About
Reviews
Contact
Privacy
Terms of Service
RESOURCES
Blog
Free Courses
Free Tutorials
Investment Banking Tutorials
Financial Modeling Tutorials
Excel Tutorials
Accounting Tutorials
Financial Statement Analysis
COURSES
All Courses
Financial Analyst All in One Course
Investment Banking Course
Financial Modeling Course
Private Equity Course
Venture Capital Course
Excel All in One Course

Copyright © 2021. CFA Institute Does Not Endorse, Promote, Or Warrant The Accuracy Or Quality Of WallStreetMojo. CFA® And Chartered Financial Analyst® Are Registered Trademarks Owned By CFA Institute.
Return to top

WallStreetMojo

Free Investment Banking Course

IB Excel Templates, Accounting, Valuation, Financial Modeling, Video Tutorials

* Please provide your correct email id. Login details for this Free course will be emailed to you

Book Your One Instructor : One Learner Free Class
Let’s Get Started
Please select the batch
Saturday - Sunday 9 am IST to 5 pm IST
Saturday - Sunday 9 am IST to 5 pm IST

This website or its third-party tools use cookies, which are necessary to its functioning and required to achieve the purposes illustrated in the cookie policy. By closing this banner, scrolling this page, clicking a link or continuing to browse otherwise, you agree to our Privacy Policy

Login

Forgot Password?

WallStreetMojo

Free Accounting Course

You will Learn Basics of Accounting in Just 1 Hour, Guaranteed!

* Please provide your correct email id. Login details for this Free course will be emailed to you

WallStreetMojo

Download EOQ Formula Excel Template

Special Offer - All in One Financial Analyst Bundle (250+ Courses, 40+ Projects) View More