Using EOQ for optimal reorder quantities

Economic Order Quantity (EOQ) is a formula that helps businesses determine the optimal order quantity to minimise total inventory costs. It balances ordering costs (costs incurred when placing an order) and holding costs (costs associated with storing inventory), ensuring that stock is replenished efficiently and cost effectively.

EOQ formula

The EOQ formula is:

Where: D = Annual demand (units per year) S = Ordering cost per order H = Holding cost per unit per year

This formula calculates the ideal order quantity that minimises the total cost of inventory management.

Key Components of EOQ

• Ordering costs – Expenses related to placing an order (eg administrative costs, supplier fees, shipping).
• Holding costs – Costs incurred to store inventory (e.g., warehousing, insurance, depreciation).
• Demand rate – The number of units needed annually to meet customer demand.

Example calculation

Suppose a business has:

• Annual demand (D) = 10,000 units
• Ordering cost per order (S) = $50
• Holding cost per unit per year (H) = $2

Using the EOQ formula:

This means the company should order 707 units per order cycle to minimise costs.

Benefits of EOQ

• Cost savings – Reduces unnecessary inventory storage and ordering expenses.
• Improved cash flow – Ensures that capital is not tied up in excess stock.
• Efficient reordering – Determines the best quantity to purchase, reducing stockouts and overstocking.
• Optimised supply chain – Streamlines procurement and inventory replenishment.

Limitations of EOQ

• Assumes constant demand – Real-world demand fluctuations may require adjustments.
• Ignores supplier constraints – Bulk discounts, lead times, and storage limits are not factored in.
• Doesn’t account for perishable goods – Works best for non-perishable inventory.