EOQ (Economic Order Quantity)

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 costDirect CostDirect costs are costs incurred by an organization while performing its core business activity and can be attributed directly in the production cost, such as raw material costs, wages paid to factory staff, power & fuel expenses in a factory, and so on, but do not include indirect costs such as advertisement costs, administrative costs, etc.read more 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

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

You are free to use this image on your website, templates etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: EOQ (Economic Order Quantity) (wallstreetmojo.com)

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 costsHolding CostsHolding cost refers to the cost that an entity incurs for handling and storing its unsold inventory during an accounting period. It is calculated as the sum total of storage cost, finance cost, insurance, and taxes as well as obsolescence and shrinkage cost.read more 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

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 –

Reader Interactions

Comments

  1. Kidist Tadesse says

    I really love yr simple examples showing how to calculate EOQ
    Tx

    • Dheeraj Vaidya says

      Thanks for your kind words!