What is the formula for EOQ (Economic Order Quantity)


What is an EOQ?

Economic order quantity or EOQ is used in cost accounting to calculate the amount of optimum stock levels for a product that must be maintained to prevent stock shortages and overstocking. Under-inventory leads to lost sales while over-stocking increases overall costs and waste and reduces cash flow. EOQ is also known as optimum lot size and is a tool that calculates the correct stock levels. EOQ is especially useful for small businesses that find it difficult to manage inventory. It serves as a starting point for understanding how much inventory should be kept so that there is sufficient inventory to run the business effectively.

The EOQ formula is based on certain assumptions. First, it assumes customer demand, purchase order lead time, bearing cost, and order cost for a particular product. Second, EOQ assumes that you will place an order with the same quantity for each reorder. Third, it assumes that there is no inventory cost involved, which means you never suffer from no inventory. Fourth, EOQ assumes that regardless of order size, you will pay the same amount on a per-unit basis. This means that the formula assumes that you regularly check inventory and demand levels. Finally, it does not take quality costs into account when calculating optimal inventory levels.

Why use EOQ?

The EOQ formula is used because it has many benefits such as the following.

lower costs

EOQ enables companies to reduce costs such as bearing costs because you do not keep inventory unnecessarily in the warehouse for long periods of time. This cost reduction means that the capital can be used elsewhere in more productive areas of business growth such as increasing the production of frequently purchased products.

Promotes space optimization

EOQ helps your business to better optimize space. If there is an overstock, the products that are not yet sold hold storage space for a long time. With the right inventory on hand, there is no wastage of space which means the products being sold are stored. Space is effectively utilized when you know how much inventory your business should have at a given point in time.

Improves customer satisfaction

The EOQ formula helps companies provide better service to their customers. Nothing discourages customers more than knowing that the product they need is out of stock. Businesses can ensure that they maintain the correct stock levels at all times so that they can keep their customers happy. This can increase customer loyalty and trust.

Increases employee productivity

EOQ improves employee productivity because the business runs more efficiently. When a company is aware of the actions it has to take, it can reduce wastage and improve efficiency. EOQ can be used in addition to inventory management. It can help employees know what to do so that they are better prepared and work better.

Facilitates repeat purchases

EOQ is useful for companies that make frequent purchases. It can detect which products fit the JIT model and how much inventory to keep. Since recurring purchases will be part of the business when using EOQ, it can strengthen supplier relationships and ensure that the stock situation never occurs. For example, setting reorder levels ensures that you can properly store your inventory without delays.

EOQ Formula and EOQ Factors

The EOQ formula is as follows.

EOQ = square root of [(2 x demand x ordering cost) / carrying cost]

Requests

Demand remains constant as per the assumptions made by EOQ. Demand is the amount of inventory used annually or the number of units sold annually.

Cost arrangement

The EOQ formula contains the order cost which is a fixed cost. This is the amount you spend on submitting your application and then receiving it. This cost includes all the resources you need to receive the order. For example, making calls, sending reminder emails and taking costs related to delivery are used to calculate the cost of an order. It also includes the time it takes for the order to reach you. The cost of an order can be calculated by dividing the demand annually by the volume per order. When you have to pay a fixed amount for the order regardless of the order quantity, you can calculate the order cost annually by dividing the order annually by the volume per order multiplied by the given cost.

cartage

Book cost is also known as storage cost or inventory holding cost. This is what you need to spend to store your inventory in the warehouse. The book cost includes warehouse fees and opportunity costs. If the inventory is destroyed or stolen from the warehouse, it can be part of the transportation cost. If you pay interest to purchase inventory, the amount you pay to the bank must be part of the transportation costs. Insurance costs in relation to inventory are also taken into account when calculating the cost. Carrying costs are variable costs because they will depend on your inventory.

Example of EOQ Formula

The EOQ formula is best understood with a simple example. Let’s say you are a retailer of dog products. You sell leashes, muzzles, brushes, candy, collars, chews, bowls, dog food and more. You want to know how much designer collar stock you should keep. You sell each designer hoop for $7. In a month, she sells 30 collars, which is the equivalent of 360 collars per year. The order cost is $10 per order because you take into account processing time and the people who work for you. The cost of carrying collars is $2 per unit and this includes the opportunity cost.

Here’s how to calculate the economic order quantity for this scenario.

EOQ = square root of [(2 x demand x ordering cost) / carrying cost]

EOQ = square root of [(2 x 360 x 10) / 2]

EOQ = square root of [3600]

EOQ = square root of [3600]

EOQ = 60

This means that you need a minimum of 60 gaskets in stock to ensure you are properly stocked at any time. You can use the same EOQ formula to calculate how many leashes, muzzles, handlers, and chews you should keep in order to avoid overstocking and overstocking.

EOQ Formula Calculators

You do not need to manually calculate with the EOQ formula although this is possible if there are no large accounts involved. In general, small business owners prefer to use online calculators that require input of transportation costs, ordering, etc. Not every calculator is built the same way and your EOQ can vary depending on which calculator you choose to use. In some cases, the calculator can require more than one type of input which means you need to have costs ready with you so the calculation doesn’t take too long.

How can the program help?

The data is the basis for calculating EOQ using the EOQ formula. Accounting software with inventory management capabilities ensures that you have the right data at any time. Tally Prime Complete Business Management helps you manage your optimal inventory level. Inventory control such as reorder level helps you eliminate risks arising from overstocking as well as stock shortages.

The Reorder Status Report is very useful because it summarizes the basic information about your stocks and pending purchase orders, most importantly, you will get to know the shortage and the amount of inventory that needs to be replenished.

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