EOQ Formula – Definition
Economic Order Quantity (EOQ) refers to the optimal quantity of inventory that a company must buy in order to satisfy consumer demand to reduce logistics costs, overstock costs and warehouse spacing.
The EOQ formula helps in calculating out ideal order quantities for a cost effective supply chain.
Significance of EOQ Formula in an E-Commerce Business
EOQ calculations majorly impact a businesses’ bottom line. It helps you manage the company’s inventory efficiently. Some top benefits of EOQ inventory management includes:
- Lowers inventory costs – Businesses may establish the ideal order quantity they need to reduce expenses associated with stock acquisition and free up capital by meeting demand.
- Curbs storage costs – The EOQ model helps businesses reduce the quantity of inventory storage they need to keep, which can lower overall storage expenses.
- Lowers overall risk of stock outs – Economic order quantity formula aids in efficient inventory calculations making sure that a business carries out inventory replenishments as and when necessary.
- Boosts efficiency – Regular EOQ calculation helps in improving overall warehouse efficiency with smart and data-backed decisions.
Applications of the EOQ Formula
Using the Economic Order Quantity formula gives an optimal order quantity that a business needs to save money on logistics. Some basic applications of the EOQ formula include –
- The specific calculation of the amount of inventory needed to be kept in hand to increase profit margins.
- The number of items to be ordered each time during inventory replenishment using the annual ordering cost formula.
- The EOQ model formula determines the time frame to practice inventory replenishment with low optimal costs.
Economic Order Quantity Formula
Q= √2DS / H
Definition of Each Element Used in the EOQ Formula
The EOQ formula contains the following elements –
- Q – The number of units
- Annual Demand (D) – This is the number of goods a business anticipates selling in a calendar year.
- Order cost (S) -This covers each expense connected with a single purchase order.
- Holding cost (H) – Costs incurred to keep and store a unit of inventory for a year. It can be calculated using the formula:
Holding costs =
(Storage cost + employee salaries + opportunity costs + depreciation costs)
total value of annual inventory
How To Use the EOQ Formula To Calculate a Business’ Turnover Ratio?
Assume a company XYZ sells 10,000 smartphones each year (on average). The order cost per order is A$100, and the annual holding fee for each smartphone is A$10.
Therefore, using the optimal order quantity formula, the EOQ is calculated as –
Q = √2DS / H
Q = √ 2x 10,000 x 100 / 10
Q = 200√5
Q = 447.21
Thus, from the order quantity formula, the ideal order quantity for XYZ would be 447 units (rounded off).
What Can You Infer From the Result of the EOQ Formula?
By using the EOQ formula, a business can calculate the optimal quantity for inventory replenishment. This formula helps lower logistics and warehousing expenses at the same time ensures that the business doesn’t face challenges due to stockouts or overstocking .