Economic Order Quantity is the calculating method used to determine the best level of inventory for production while being the most cost effective for holding and ordering. EOQ, as it is referred to, has been around since the rise of modern manufacturing processes back
Economic Order Quantity is the calculating method used to determine the best level of inventory for production while being the most cost effective for holding and ordering. EOQ, as it is referred to, has been around since the rise of modern manufacturing processes back in the early 20th century. The first model for calculating EOQ was designed in 1913 by F.W. Harris.
What EOQ basically does is determine the best point where the costs for inventory holding and ordering are at the lowest. This helps to determine the number of units of stock to order to re-supply inventory without spending too much money on overstock.
How Does EOQ Work?
EOQ is not used in every type of business and industry. Most companies that deal with large volumes of stock use a form of EOQ. It is common in manufacturing where the ordering of stock is constant and repetitive. EOQ is primarily used for purchase-to-stock distributors and make-to-stock manufacturers. These are businesses that have multiple orders, release dates for their products, and have to plan for their components.
Another type of business that uses EOQ are those that have maintenance, repair, and operating inventory (or MRO). Businesses that have a steady demand for stock are the most suitable for EOQ applications but some seasonal items can benefit from the method, too.
How To Calculate EOQ
Economic Order Quantity must be calculated using a mathematical equation. By using a set of numbers for production, demand, and a few other variables, a company’s inventory costs can be minimizes. Here is the equation for EOQ:
The sub-components that make up the equation are as follows:
Annual Usage – This part is pretty self-explanatory. Based on units, a company simply enters the predicted annual usage amount.
Order Cost –This component is the sum of the fixed costs that occur every time an item is ordered. They are not associated with the quantity ordered, only with the actual physical act required to process the order.Also known as purchase cost or set up cost.
Carrying Cost – This part is the