What is an EOQ?

EOQ stands for Economic Order Quantity. It’s the optimum amount of inventory that a business should possess at any given point. As a projection, it works best for businesses that have a consistent demand for their products or can accurately assess upcoming consumer demand. While many large corporations use it, it can also assist smaller businessesthat have regular inventory demands and want to optimize their cash flow.

One of the most useful purposes of an EOQ calculation is that it helps businesses avoid running out of stock for products that are in demand. Being unable to sell a product due to lack of inventory is a problem that impacts many businesses and reduces their profits. Consumers tend to seek a competing product and take their business elsewhere rather than placing a backorder or waiting foryour product to come back in stock.

What is an economic order quantity formula?

To reduce holding, order fulfillment and shortage costs, you can use an optimal order quantity calculator, often referred to as an Economic Order Quantity (EOQ) calculator. The calculatordetermines how much of any given product to store given your past sales trends and demand. It’s important to consider that an EOQ calculator is most effective if your costs and sales are consistent. If you’re experiencing swings in demand or don’t have fixed costs, this might make the calculator less effective.

Before using any calculators to assist ininventory management, it’s important to know how they work and what factors are considered in the equation. An EOQ calculator performs a relatively simple math equation. It takes theannual demandfor a product, multiplies it by the cost of each order, doubles the result and then divides it byyour holding cost. The square root of this result is the number of EOQ units that should be held in inventory for that product.

This isn’t the only tool that businesses use to manage their cash flow. It’s one of many formulas that can help management make the right decisions regarding inventory management and restocking. When using an EOQ calculator, it’s important to keep in mind that the results are a guide and don’t account for some of the factors you’d consider when deciding when to order more inventory.

Who uses optimal order quantity calculators?

Businesses that have large supply chains use calculators to determine when it’s appropriate to order more inventory. Whenever inventory dips below the minimum inventory calculated, a business places an order for more product so that it arrives before it runs out of stock. Medium to large corporations want to keep as little inventory on hand as possible because while it sits in a warehouse, it costs money to rent storage space and to transport it to the endpoint of delivery.

For example, if a business sells 5,000 units per year, it costs $10 to hold it in inventory, and it costs an additional $2 to place an order for restocking, then the calculator determines that the business should hold 45 units at a time. When the inventory falls under 45, the business orders another 45 units. This ensures that the company never runs out of product while reducing the space required to hold inventory and the storage cost.

As the cost of storage and sales demand change, it’s important to update these calculations to determine whether you need to order more or less frequently from your vendors. In addition, it’s a good idea to assess your EOQ once each year, as variations throughout the year can throw the equation off.

Factors that determine optimal order quantity

Since calculating your optimal inventory storage isn’t an exact science, the formula might be impacted by factors that aren’t under your control. It can’t predict changes to your costs, the demand for your products, trade regulations, tax policies and other economic factors. Sometimes it may be in a company’s best interest to make a purchase when costs are lower and hold onto the inventory for longer than it would to not take advantage of the discount, for example.

Holding costs may fluctuate as well. It’s best to attempt to maintain consistency when you’re able to when projecting how these factors impact a company’s cash flow to avoid costly decisions. Any money saved on discounted inventory may be eaten up if the product remains unsold for too long.

An EOQ calculator also can’t account for seasonal sales trends. For example, your business might see most of its product sales during certain times of the year. An example is the floral industry, which sees spikes in demand during holidays like Valentine’s Day and Mother’s Day or during the wedding season. If you experience similar highs and lows, an EOQ calculator might actually force you to hold onto leftover inventory as the business heads into a slow period.

The best time to use an EOQ calculator

Since consistency is important to receive an accurate result from the calculator, it’s best to use one when the following conditions are met:

• Company sales are consistent: You need an accurate estimate for the year’s sales to know how much product to hold and thebest priceto sell it for. If sales trends are consistent, the calculator can give an accurate assessment.
• Consistent holding costs: Some of the holding coststhat businessesincur are the cost of renting warehouse space, transportation costs and other incidental charges. If these costs are in constant flux, the calculator can’t account for these irregularities.
• Employee wages remain the same: Pay increases need to be considered in cost calculations ifyouwant the most accurate result.
• Vendor costs remain the same: If the vendors offer discounts for products at certain points throughout the year or for buying products in bulk, this can have a significant impact. If you’re presented with the opportunity to buy more products at a discount, one way to solve this is to run the calculation at both product price points to determine if the discounts are worth the extra holding costs.

How to use an optimal order quantity calculator

Using an EOQ calculator is rather straightforward. Allyouneed to do is input the demand for each product, the cost to place an order and how much it costs to hold the product in inventory. The best practice is to use annual figures for the holding costs and product demand, so use past sales trends oryour best projection for the upcoming year when filling in the fields.

Youcan use the calculator to determine how changes in customer demand, product cost and holding costs impact the figuresyoureceive as well. This helps determine whether it’s truly worth it to take a bulk discount a vendor offers or if it’s best to continue ordering at more frequent intervals. Businesses also use EOQ calculators to see how changes to the economy and market impact their bottom lines.

Ifyou’re expecting a lower demand due to a poor economy or increased transportation costs due to volatility in the oil industry,youcan factor these changes intoyour calculations and make adjustments toyourinventory managementstrategy. Businesses tend to hold onto less inventory when holding costs increase and increase their stock when experiencing elevatedproduct setup costs or consumer demand. Calculators aren’t crystal balls, so try to find a balanced inventory management strategy that considers all factors while determining what works best for your business.