Economic Order Quantity (EOQ)

An Economic Order Quantity (EOQ) is an inventory-related evaluation to determine the optimum order quantity which a company should use to ensure that Inventory is not overstocked whilst at the same time maintaining sufficient stock to prevent a stock-out. The objective therefore is to minimise the combined costs of acquiring and carrying inventory.

The Formula used is based on the fact that the greater the number of orders placed per year would contain fewer items per order which results in lower Inventory holding costs but would incur a larger overall ordering cost. Conversely, the fewer orders that are placed per year would contain larger quantities per order but have lower overall ordering costs. This however, results in Inventory being held in stock for longer periods resulting in increased holding costs. Combining these two costs you get a graph as shown below:

The EOQ calculation takes into account both the Ordering Cost and the Holding Cost to arrive at the EOQ for the Item. This then provides information to recommend an economic and realistic Suggested Order Quantity.

The EOQ formula uses the following parameters:-

• A = Average weekly usage taken from all issue movements over the previous year.
• C = Carry factor expressed as a percentage
• O = Ordering cost, as entered
• U = Current Average ‘Cost’ of the Item.

                       ________________
Then EOQ = / 2 * (52 * A) * O
                   / -------------------
                \/         C * U

Where

• Annual Usage -(52 * A) in the above formula
  

  The quantity of the item used in the past year. In the above formula this is expressed as Average Weekly Usage * 52 weeks. This allows us to calculate instances where the Item has existed for less than one year. Our formula determines the actual weekly usage from the time it was created.

• Order Cost - 'O' in the above formula
  

  This is the sum of the fixed costs that are incurred each time an item is ordered. These costs are not associated with the quantity ordered but primarily with physical activities required to process the order such as the cost to enter the purchase order and/or requisition, any approval steps, the cost to process the receipt, incoming inspection, invoice processing and Supplier payment.

• Carrying Cost - (C * U) in the above formula
  

  This is primarily made up of the costs associated with the inventory investment and storage cost and can include Cost of putting away stock receipts and moving material within the warehouse, Rent and utilities for the portion of your warehouse used to store stock inventory, Insurance and taxes on inventory, Physical inventory and cycle counting, Inventory shrinkage and obsolescence, etc. The Carry Factor cost percentage is calculated by dividing the sum of the above Carrying Costs by the average inventory value.

We are in the process of including Economic Order Quantity (EOQ) as functionality in Ostendo Operations Software.