Every time you order stock, you face a trade-off. Order often in small amounts, and you pay for lots of orders. Order rarely in large amounts, and you pay to store a lot of stock. The economic order quantity, or EOQ, is a classic way to find the point where those two costs balance. It will not be exactly right for your business, but it is a very useful starting point.
The two costs in conflict
Ordering costs are what it costs you each time you place an order: administration, shipping charged per order, receiving and checking the delivery. Holding costs are what it costs to keep a unit in stock for a year: storage, insurance, damage and the cost of the cash tied up. More orders means higher ordering costs and lower holding costs, and fewer, larger orders do the opposite. EOQ finds the quantity where the total is lowest.
The formula
EOQ = √(2 × annual demand × cost per order ÷ holding cost per unit per year).
A worked example
A business sells 3,600 units a year. Each order costs 40 to place and receive, and holding a unit costs 3 a year. EOQ = √(2 × 3,600 × 40 ÷ 3) = √96,000, which is about 310 units. At that size, the business orders about 11.6 times a year, roughly once every 31 days.
The yearly cost at 310 units is about 464.50 in ordering (11.6 orders at 40) plus 465 in holding (an average of 155 units at 3), a total of roughly 929.50. The two parts are almost equal, which is the sign that you are at the optimum.
What happens if you order differently
Order 600 units at a time and you place 6 orders, costing 240, but you hold an average of 300 units, costing 900. The total is 1,140. Order 100 at a time and you place 36 orders costing 1,440, with an average of 50 units held, costing 150. The total is 1,590. Both are worse than the 929.50 at the optimum, and ordering in small batches can cost far more than most people expect.
The curve is forgiving
The total cost curve is flat near the minimum. Ordering 280 or 340 instead of 310 changes the total by only a little. That means you can round to a convenient number, such as a full case or pallet, without losing much. The mistake to avoid is a large departure from the optimum in either direction.
Where the numbers come from
Use real data. Annual demand comes from sales history, adjusted for growth. Ordering cost is the full cost of placing and receiving one order, not the price of the goods. Holding cost per unit is often estimated as a percentage of unit cost. If you are unsure, see our guide on carrying costs and the carrying cost calculator.
The limits of EOQ
EOQ assumes steady demand, a constant lead time, fixed costs and no quantity discounts. Real businesses have seasons, minimum orders, pack sizes and discounts for ordering more. Treat EOQ as a baseline and then adjust for these. If a supplier offers a lower price for bigger orders, compare the total yearly cost at each price level, including the cost of goods and not only ordering and holding.
Shelf life and storage space
If a product expires or goes out of fashion quickly, a smaller order than EOQ may be safer. If storage is limited, your order size may be capped by space. Cash is also a constraint: an EOQ order may be bigger than you can comfortably pay for.
EOQ and the reorder point
EOQ answers how much to order. It does not say when. The reorder point answers that, based on demand during the supplier's lead time plus a safety buffer. You need both. See reorder points and safety stock.
A checklist before you rely on it
Ask yourself a few questions. Is demand fairly steady? Have I included every cost of placing and receiving an order? Is my holding cost realistic? Does the supplier have minimum quantities or fixed pack sizes? Are there price breaks for larger orders? Do I have the cash and the space? If the answers support the assumptions, EOQ is a good guide. If not, treat it as one input among several.
Doing it in a spreadsheet
In a spreadsheet, the formula is =SQRT(2*D*S/H), with annual demand, order cost and holding cost in separate cells. Build a small table with different order quantities down the side and the yearly ordering cost, holding cost and total beside them. A chart of the total makes the shape of the curve obvious, and you can see how little the cost changes close to the optimum.
When to use it
EOQ works best for products with steady demand that you order repeatedly. For one-off or highly unpredictable items, it matters less. Review your inputs once a year, or when costs or demand change. Try our EOQ calculator with your own numbers. This guide is general information, so test the result against your own situation.
