Economic order quantity (EOQ)
What is meant by economic order quantity EOQ?
Economic Order Quantity (EOQ) is a method used to determine the optimum order quantity for an item of stock. The method looks for ways to minimise ordering and carrying costs.
Inventory needs differ across industries and sectors. For example, consumer goods producers require well-balanced inventories at the point of sale. Clients of industrial and commercial producers usually do not require the same degree of delivery lead time. Smaller businesses also face financial and logistical limitations when starting their inventory systems, so it’s key that you choose the most effective method that suits your organisation.
If you’re looking at applying this method in your organisation, you’ll need to perform ‘inventory segmenting’ or ‘inventory partitioning.’ This practice requires a breakdown and review of total inventory by classification, inventory stages (raw materials, intermediate inventories, finished products), sales and operations groupings and excess inventories. This enables you to break down your inventory into much more manageable parts, which will prepare you for your analysis.
What is economic order quantity (EOQ) formula?
Economic order quantity is a calculation that is used to find the optimal order quantity for businesses, with the aim of minimising logistic costs, warehouse spaces and overstocks. The economic order quantity model was designed to help companies to minimise inventory costs and was developed by F.W. Harris.
There are several ways to calculate the Economic Order Quantity, but a basic formula is as follows: 
√ 2DS/CI,
- Where D is annual anticipated demand
- S is the order cost per order
- C is the cost of the item
- I is an annual carrying cost interest rate
However, before applying this basic formula it’s important to understand that is based on several assumptions:
- Demand is uniform
- Lead times are certain
- There are no limits on order size
- Cost of placing the order is independent of the order size
- Cost of holding the stock does not depend on the quantity
- All prices are constant
- The same quantity is ordered each time
Why is economic order quantity important in inventory management?
Whatever the size of your organisation, having effective inventory management will help reduce costs and stockholding.
What are the advantages of using the Economic Order Quantity method?
- EOQs are often good for repetitive procurement scenarios.
- EOQs make it easy to determine which items fit into a just-in-time (JIT) model and what level is economically beneficial for the company.
- The EOQ method helps you maintain a commitment to ordering in a stable manner from suppliers. This helps to minimise the risk of being in a position where you cannot supply a key customer’s order, which could result in stock outs for that customer.
However, there are potential disadvantages of using the Economic Order Quantity model too, which are:
- Order costs are assumed to be constant. However, these may fluctuate from time to time.
- Interest rates are assumed to be constant, but these frequently change.
- Inaccurate data input can cause huge problems, such as exaggerated carrying and order costs.
What is operations management?
Operations management is a key area within any organisation. It plays a key role in keeping supply chains operational in today’s challenging environment. Discover the key to success when thinking about operations management
Find out more about Operations Management
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