Economic Order Quantity (EOQ): Definition, Calculation Method, and Its Types

The application of methods in warehouse management is essential for companies to optimize their operations. One commonly implemented method is the Economic Order Quantity (EOQ) calculation, which helps balance ordering and storage costs with the order quantity to prevent stock shortages.

Definition of Economic Order Quantity

Economic Order Quantity (EOQ) is a calculation method applied in warehouse management to determine the optimal order quantity with minimal inventory costs. The total inventory cost includes ordering cost and holding cost.

Applying the EOQ method helps companies determine the ideal amount of stock to order, ensuring there is neither a shortage nor an excess of inventory.

Key Components in Economic Order Quantity

When determining EOQ, there are three main components that must be included in the calculation, namely:

1. Ordering Cost

Ordering cost refers to the expenses incurred each time a company places an order for stock, such as administrative costs, transportation fees, and order processing costs. Generally, these costs increase as the number of orders rises.

2. Holding Cost

Holding cost refers to expenses related to storing inventory in the warehouse, such as warehouse rent, insurance, risks of damaged or obsolete stock, and the capital tied up in inventory.

3. Purchase Cost

Purchase cost is the expense incurred when the company buys goods from suppliers. In the EOQ method, this cost is generally not affected by the order quantity.

Types of Economic Order Quantity

Economic Order Quantity has several variations or types that arise under certain conditions when applying the EOQ method. The following are several EOQ model types:

1. EOQ with Quantity Discounts

This EOQ type considers price reductions when buying in large quantities. In addition to ordering and holding costs, the company must also calculate the benefit of lower purchase prices to determine the optimal order quantity.

2. EOQ with Stockout

This model accounts for the risk of running out of stock and related costs, such as lost revenue and emergency order costs. It is suitable for businesses with uncertain demand or those wanting to avoid losing customers due to stockouts.

3. Production Order Quantity (POQ)

This version of EOQ is a variation used when companies produce stock internally. The model considers the gradual production rate rather than purchasing large quantities at once, making it more suitable for continuous production processes.

4. EOQ with Variable Demand

This EOQ model is designed for companies facing fluctuating market demand. It is more flexible in determining order quantities, allowing adjustments for seasonal changes, market trends, and other external factors.

How to Calculate Economic Order Quantity

In general, warehouse management using the Economic Order Quantity (EOQ) method can apply the following formula:

Here’s the breakdown of the formula:

EOQ = Economic Order Quantity (optimal order quantity)

D = Annual demand

S = Ordering cost per order

H = Holding cost per unit per year

This formula provides the optimal quantity of goods that should be ordered each time to minimize total inventory costs.

To better understand the EOQ calculation formula, here’s an example:

A company has an annual demand of 20,000 units. To meet this target, the company incurs an ordering cost of $2,000,000 per order. Additionally, the annual holding cost per unit is $20,000. Therefore, the calculation is:

Thus, based on the EOQ calculation, the optimal order quantity the company should place is 2,000 units per order, allowing the company to minimize total inventory costs.

Apply Economic Order Quantity with Prieds WMS System

Companies can apply various warehouse management methods according to their needs to ensure optimal warehouse operations. One such method is Economic Order Quantity (EOQ), which helps balance ordering and holding costs with the order quantity to avoid stock shortages.

Implementing the EOQ method in warehouses using advanced systems makes it easier for companies to perform calculations and determine more accurate inventory quantities to purchase.

As a provider of Warehouse Management Software (WMS), Prieds offers a system that helps companies implement the Economic Order Quantity (EOQ) method in warehouse management efficiently and accurately.

Through the implementation of Prieds WMS, companies can configure the system according to their operational needs and integrate it with other systems or devices such as RFID. This allows them to optimize warehouse management through accurate EOQ implementation, gain real-time stock visibility, and improve overall operational performance.

Learn more about how to apply the Economic Order Quantity (EOQ) method in warehouse management with Prieds WMS by consulting with our expert team. Get a system equipped with complete features, top security, and user-friendly functionality tailored to your company’s needs with Prieds.