What EOQ is used for
EOQ answers a focused question: how many units should be ordered each time if annual demand, cost per order, and annual holding cost per unit are stable. Ordering too often raises administrative, freight, receiving, and setup costs. Ordering too much ties up cash, warehouse space, insurance, shrink, and obsolescence risk.
The model works best for repeatable items such as packaging, spare parts, ingredients, and steady catalog products. It is less reliable for fashion goods, one-time buys, highly volatile demand, capacity-constrained suppliers, or items with steep quantity discounts.
- Buyers use EOQ to set default purchase quantities.
- Operations teams use it to reduce total inventory cost.
- Finance teams use it to explain the cash effect of order policies.
How to calculate EOQ
The EOQ formula is: EOQ = sqrt((2 x D x S) / H). D is annual demand in units, S is the cost to place one order, and H is the annual holding cost for one unit. H may be a dollar amount or unit cost multiplied by a carrying-cost percentage.
Example: annual demand is 12,000 units, ordering cost is 75 dollars per order, and holding cost is 2 dollars per unit per year. EOQ = sqrt((2 x 12,000 x 75) / 2) = sqrt(900,000) = about 949 units. The business would place about 12,000 / 949 = 12.6 orders per year.
Connect EOQ to reorder point
EOQ tells you how much to order, not when to order. Reorder point handles timing: reorder point = demand during lead time + safety stock. If average demand is 40 units per day and lead time is 10 days, lead-time demand is 400 units. With 120 units of safety stock, the reorder point is 520 units.
Safety stock should reflect demand variability, supplier variability, and the service level you need. A low-margin, easy-to-substitute item may tolerate lower safety stock. A critical production part may need a higher buffer even if EOQ suggests a tidy order quantity.
- Use EOQ for order size.
- Use reorder point for order timing.
- Use safety stock for uncertainty.
Common EOQ mistakes
The biggest mistake is treating EOQ as a rule when the assumptions do not hold. Supplier minimums, price breaks, container quantities, shelf life, and budget limits can all override the pure formula. EOQ is a cost model, not a contract with reality.
Another mistake is underestimating holding cost. Carrying inventory is not just warehouse rent. It can include capital cost, insurance, taxes, damage, cycle counting, expiration, and markdown risk. If H is too low, EOQ will recommend orders that are too large.
Frequently asked questions
Does EOQ include purchase price?
The basic EOQ formula assumes unit purchase price is constant, so purchase price does not affect the optimum. If suppliers offer quantity discounts, compare total cost at each price break.
Can EOQ be used for seasonal products?
Only with care. Use season-specific demand instead of annual demand, and consider end-of-season leftover risk.
What is ordering cost in EOQ?
Ordering cost is the fixed cost of placing and receiving an order, such as buyer time, purchase order processing, freight minimums, inspection, and setup.
How often should EOQ be recalculated?
Recalculate when demand, lead time, freight, supplier terms, warehouse cost, or carrying-cost assumptions change materially.