Economic Order Quantity (EOQ) is a formula used in inventory management to determine the ideal quantity of inventory to order at any given time. The formula takes into account various factors such as the cost of holding inventory, the cost of ordering inventory, and the demand for the product.
EOQ = √(2SO/C)
- S =Annual Sales (in units)
- O = Cost Per Purchase Order
- C = Annual Carrying cost Per Unit
While managing inventory, there is a trade-off between carrying cost and ordering cost. For example, if the order quantity is small then carrying costs are low, but inventory must be ordered more frequently to meet demand, which increases ordering costs.
Ordering Costs typically represents the cost of labor associated with order placements. It includes costs of entering the purchase order, processing the receipt of the inventory, inspecting the inventory to ensure that the goods received are acceptable and processing of vendor invoice and consequent payment.
Carrying Costs include Storage Costs, Insurance Costs, opportunity costs of inventory investment & lost inventory due to spoilage.
EOQ inventory model attempts to minimize total ordering and carrying costs. EOQ assumes that demand is known and is constant throughout the year. EOQ also assumes that carrying costs per unit and ordering costs per unit are fixed.