Eoq Definition Formula Calculate Economic Order Quantity

What is EOQ?

EOQ Formula

Let us look at the critical components of EOQ and its formula –

#1 – Holding Cost

Holding cost is the cost of a holding inventory in storage. The direct costDirect CostDirect cost refers to the cost of operating core business activity—production costs, raw material cost, and wages paid to factory staff. Such costs can be determined by identifying the expenditure on cost objects.read more needs to be calculated to find the best opportunity to store inventory or, instead of investing it somewhere else- assuming demand to be constant.

H = i*C

Where,

H= Holding costi= Carrying costC= Unit cost

As demand is constant, inventory will decrease with usage when it reduces to zero-order placed again.

#2 – Ordering Cost

Ordering is the cost of placing an order to the supplier for inventory. The annual quantity calculates the number of orders demanded divided by the volume per order.

Number of orders = D / Q

D = Annual quantity demandedQ = Volume per orderAnnual Ordering Cost

An annual ordering cost is the number of orders multiplied by ordering costs.

Annual ordering cost = (D * S) / Q

S = Ordering cost

#3 – Annual Holding Cost

Annual holding cost is the sum of volume per order and holding cost, which can be written as.

Annual Holding Cost= (Q * H) / 2

#4 – Total Cost

The sum of the two costs gives an annual total cost of an order.

We get the below equation by adding annual ordering and holding costs.-

Annual Total Cost or Total Cost = Annual ordering cost + Annual holding cost

Annual Total Cost or Total Cost = (D * S) / Q + (Q * H) / 2

To find EOQ – Economic Order Quantity Formula, differentiate total cost by Q.

EOQ = DTC / DQ

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Examples

Example #1

Let’s take an example to calculate EOQ – Economic Order Quantity for a pen manufacturing company where the company’s annual quantity demanded is 400, the holding cost is $2, and the ordering cost is $1. Now we will put these values in the above equation.

In the below-given figure, we have shown the calculation for the EOQ for a pen manufacturing company.

So, the calculation for EOQ 2 = (24001)/2

Therefore ,EOQ =20.

Example #2

Let us understand this with an example. A company named Den Pvt. Ltd. wants to know EOQ as it is a tool to calculate the volume and frequency of orders required to minimize the cost per order.

The below-given table is the data for the calculation of EOQ – Economic Order Quantity Formula for company Den Ltd.

Take the below assumption.

Through the above data, we get below the graph.

From it, we can see that EOQ is 250. Hence, EOD sets a point that minimizes the cost of inventory.

Example #3

A company manufactures steel boxes that it needs to calculate the quantity required. EOD needs to be calculated.

Taking below Assumptions:-

Ordering Cost = $10 per orderAnnual quantity demanded = 2000 unitsHolding cost = $1 per unit

In the below-given figure, we have shown the calculation of the EOQ for a manufacturing company.

So, the calculation for EOQ2=(2200010)/1

EOQ = (40000)1/2

Therefore, EOQ = 200

Further, we will calculate holding, ordering, and the number of orders per year and combine ordering and holding costsHolding CostsHolding cost refers to the cost that an entity incurs for handling and storing its unsold inventory during an accounting period. It is calculated as the sum total of storage cost, finance cost, insurance, and taxes as well as obsolescence and shrinkage cost.read more at economic order quantity.

Numbers of orders per year

The below table shows the calculation of the number of orders per year.

A number of orders per year = Annual quantity demanded/ EOQ.

So, the calculation of EOQ for the number of orders per year is =2000/200

Therefore, several orders per year =10

Ordering Cost

The below table shows the calculation of the Ordering cost.

Ordering cost = Number of orders per year * cost per order

So, the calculation of EOQ for ordering cost is = 10*10

Therefore, ordering cost = 100

Holding Cost

The below table shows the calculation of the Holding cost.

Holding cost = Average unit * Holding cost per unit

So, the calculation of EOQ – Economic Order Quantity Formula for holding cost is = (200/2) * 1

Therefore, holding cost = 100

Combine ordering and holding costs at economic order quantity

The table below shows the combined ordering and holding cost calculation at economic order quantity.

Ordering cost + Holding Cost

So, the calculation for combining ordering and holding cost at economic order quantity formula is = 100 + 100

Here, holding and ordering costs are the same, i.e., $100.

Therefore, combining ordering and holding costs at the economic order quantity formula is= 200

Let’s see how we can derive the same.

From this table, we also get EOQ = 200.

Relevance and Uses

Cash flow planningCash Flow PlanningCash flow plans are those in which an insurance company assesses its income and expenses in order to maintain cash flows and also to keep cash flows above expenses. It can also refer to an individual’s plan to ensure cash liquidity in such a way that they manage their expenses while maintaining a minimum balance.read more– EOQ formula is used to minimize the cost of inventory and save cash.Reordering Point- This formula calculates the reordering point, i.e., the point at which one gets a trigger to order inventory.It helps the company to reduce waste.It helps to minimize storage and holding costs.

What is EOQ?#

EOQ Formula#

#1 – Holding Cost#

#2 – Ordering Cost#

#3 – Annual Holding Cost#

#4 – Total Cost#

Examples#

Example #1#

Example #2#

Example #3#

Relevance and Uses#

Recommended Articles#