Formula of EOQ (Table of Contents)
What is EOQ Formula?
The EOQ stands for economic order quantity, EOQ formula calculates by reducing the cost of per order by setting order derivative to zero. In simple language, we can say that the EOQ equation helps to find a volume of production or order by decreasing holding cost and ordering cost.
Total cost = Purchase cost + Ordering cost + Holding cost
The components for calculation of EOQ equation are the cost of holding and cost of ordering.
#1 – Holding Cost
Holding cost is the cost of a holding of inventory in storage. It is the direct cost which 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
- 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 order is calculated by annual quantity demanded divided by volume per order.
Number of orders = D / Q
- D = Annual quantity demanded
- Q = Volume per order
- Annual Ordering Cost
An annual ordering cost is the number of order multiply by ordering cost.
Annual ordering cost = (D * S) / Q
- S = Ordering cost
#3 – Annual Holding Cost
Annual holding cost is sum product of volume per order and holding cost which can be written as.
Annual Holding Cost= (Q * H) / 2
#4 – Total Cost
Sum of two costs gives an annual total cost of an order.
By adding annual ordering cost and annual holding cost we get below equation.-
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Annual Total Cost or Total Cost = Annual ordering cost + Annual holding cost
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 Equation = DTC / DQ
Examples of EOQ Formula (with Excel Template)
Let’s see some examples of EOQ equation to understand it better.
EOQ Formula – Example #1
Let’s take an example to calculate EOQ – Economic Order Quantity for a pen manufacturing company where company’ 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 EOQ equation for a pen manufacturing company.
So, the calculation for EOQ2 = (2*400*1)/2
Therefore ,EOQ =20.
EOQ Formula – 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 below-given table is the data for the calculation of EOQ – Economic Order Quantity Formula for company Den Ltd.
Take below assumption.
By keeping above values in the below tabular equation we get total cost with a combination of different volume.
Through the above data, we get below the graph.
From it, we can clearly see EOQ is 250. EOD set point where minimize the cost of inventory.
EOQ Formula – Example #3
A company manufactures steel boxes for that it needs steel to calculate quantity required EOD need 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 EOQ equation for manufacturing company.
So, the calculation for EOQ2=(2*2000*10)/1
EOQ = (40000)1/2
Therefore ,EOQ = 200
Further, we will calculate holding cost, ordering cost, and the number of orders per year and combine ordering and holding cost 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
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
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
Therefore, holding cost = 100
- Combine ordering and holding cost at economic order quantity
The below table shows the calculation of the combine 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 cost is same i.e. $100.
Therefore, combine ordering and holding cost at economic order quantity formula is= 200
Let’s see the table how we can derive the same.
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 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 cost.
This has been a guide to EOQ Formula. Here we discuss how to calculate EOQ equation using practical examples and downloadable excel template. You can learn more about financial analysis from the following articles –