3. Economic Order Quantity
Your economic order quantity (“EOQ”) is an optimized order quantity that minimizes inventory ordering and carrying costs. There are three primary factors to consider when thinking about economic order quantity:
Projected demand: Obviously, you will still need to consider the basics of how much of a product you anticipate selling, and how much safety stock you need to order.
Cost to produce: Vendors often reward buyers with significant price cuts for higher quantity orders. If you planned on ordering 110 of an item, but would earn a 30% discount for ordering 120, then you will need to calculate the savings. Will you save more money because of the discount, or will you wind up paying more in storage fees later on?
Transportation and carrying costs: Finally, there is the question of how much it will cost to actually ship and carry the product you are ordering. The amount you order can affect shipment weight, dimensions, and the type of shipping required. For example, if one standard shipping box carries 150 items, but your demand forecast tells you to purchase 180 of an item, you will need to research how to minimize shipping costs. Additionally, to maximize your utility of the EOQ calculation, you will need to identify and annualize the storage fees and costs associated with the items you order.
To calculate an EOQ by hand, you can use the following formula:
EOQ = √2DK/h where
D = annual demand quantity
K = fixed cost per order
h = annual holding cost per unit