What does EOQ actually minimize?

EOQ minimizes the sum of annual ordering cost and annual holding cost. Ordering cost falls as you order in bigger batches; holding cost rises as those batches sit in inventory. EOQ is the order size where the two are balanced and the total is lowest. At 894 units, annual ordering cost (13 orders x $80 = about $1,073) roughly equals annual holding cost (447 average units x $2.40 = about $1,073).

How do I calculate the ordering cost input for EOQ?

Ordering Cost is the fully loaded cost of placing and processing one order, not the price of the parts. Add up buyer time, PO processing, receiving, inspection, and any changeover or setup, then divide by orders placed. If your purchasing team costs $200,000/year and handles 2,500 orders, that is $80 per order, matching the example. Exclude the unit price; it does not belong in this term.

How many orders per year should EOQ give me?

Divide Annual Demand by EOQ: 12,000 / 894 is about 13 orders per year, roughly one every four weeks. As a rough sanity check, most stable production parts land between 4 and 26 orders annually. Fewer than 2 to 3 suggests holding cost is understated; more than 40 suggests ordering cost is too low. If the frequency looks wrong, recheck those two inputs before trusting the lot size.

What holding cost rate should I use if I do not know it?

A common estimate is 15 to 30 percent of unit cost per year, covering cost of capital, warehouse space, insurance, and obsolescence. For a part costing $12, a 20 percent rate gives $2.40 per unit per year, the value in the example. Use the higher end for perishable or fast-obsolescing items and the lower end for cheap, stable commodities. Document your assumption so the EOQ is auditable.

Why does EOQ ignore minimum order quantities and pack sizes?

EOQ is a pure cost-optimization; it assumes you can order any quantity. Real constraints like supplier MOQs, case packs, truckload minimums, and shelf life are applied afterward. If EOQ is 894 but the supplier ships in cases of 250, round to 1,000 (four cases). Because the EOQ cost curve is flat near the minimum, that rounding adds only a small cost penalty, usually well under a few percent.

What is the difference between EOQ and reorder point?

EOQ answers how much to order; reorder point answers when to order. EOQ of 894 units sets the lot size and gives about 13 orders a year. The reorder point is the inventory level that triggers each of those orders, based on demand during lead time plus safety stock. They work together: reorder point fires the signal, and EOQ determines the quantity you release each time.

Supply Chain and Inventory

Economic Order Quantity Formula

Economic Order Quantity (EOQ) finds the order size that minimizes the combined cost of ordering and holding inventory. Use it when setting purchase lot sizes, kanban quantities, or MRP order multiples.

Formula

EOQ = Square Root of (2 x Annual Demand x Ordering Cost / Holding Cost Rate)

Variables

Annual Demand: Expected annual usage in units
Ordering Cost: Cost to place one order (purchasing, receiving, inspection, setup)
Holding Cost Rate: Annual cost to hold one unit in inventory (storage, capital, obsolescence risk), in $/unit/year

Understanding the Economic Order Quantity Formula

EOQ finds the order size that balances two opposing costs. Order too little and you place many orders, piling up ordering cost. Order too much and inventory sits, racking up holding cost. The formula finds the trough where those two curves cross and total cost is lowest. For 12,000 units a year at $80 per order and $2.40 per unit per year to hold, that sweet spot is 894 units, giving roughly 13 orders a year and the minimum combined cost.

Annual Demand is total yearly usage in units. Ordering Cost is the fully loaded cost to place and receive one order: purchasing labor, receiving, inspection, and any setup, not the price of the goods. Holding Cost is dollars per unit per year, covering storage, cost of capital, and obsolescence, often estimated as 15 to 30 percent of unit cost. Keep the time horizon annual on both demand and holding. Plugging in: sqrt((2 x 12,000 x 80) / 2.40) = sqrt(800,000) = 894 units.

The 894-unit answer is a flat-bottomed optimum, so ordering 800 or 1,000 barely changes total cost, which is useful when rounding to pack sizes or truckload minimums. Sanity-check it against usage: 894 units is about a 27-day supply at 12,000/year, reasonable for most parts. If EOQ implies fewer than 2 to 3 orders per year, holding cost is likely understated; if it demands weekly ordering, ordering cost is probably too low. Always reconcile EOQ against MOQs and shelf life before releasing the PO.

Worked Example

Annual demand is 12,000 units. Ordering cost is $80 per order. Holding cost is $2.40 per unit per year.

EOQ = sqrt((2 x 12,000 x $80) / $2.40)
= sqrt(1,920,000 / 2.40)
= sqrt(800,000)
= 894 units per order

Result: 894 units per order (approximately 13 orders per year)

Common Mistake

Using EOQ without accounting for minimum order quantities, supplier pack sizes, or shelf life constraints. EOQ gives the mathematically optimal lot size. Real purchase orders must also respect MOQs, freight minimums, and expiry limits.

Frequently Asked Questions

What does EOQ actually minimize?: EOQ minimizes the sum of annual ordering cost and annual holding cost. Ordering cost falls as you order in bigger batches; holding cost rises as those batches sit in inventory. EOQ is the order size where the two are balanced and the total is lowest. At 894 units, annual ordering cost (13 orders x $80 = about $1,073) roughly equals annual holding cost (447 average units x $2.40 = about $1,073).
How do I calculate the ordering cost input for EOQ?: Ordering Cost is the fully loaded cost of placing and processing one order, not the price of the parts. Add up buyer time, PO processing, receiving, inspection, and any changeover or setup, then divide by orders placed. If your purchasing team costs $200,000/year and handles 2,500 orders, that is $80 per order, matching the example. Exclude the unit price; it does not belong in this term.
How many orders per year should EOQ give me?: Divide Annual Demand by EOQ: 12,000 / 894 is about 13 orders per year, roughly one every four weeks. As a rough sanity check, most stable production parts land between 4 and 26 orders annually. Fewer than 2 to 3 suggests holding cost is understated; more than 40 suggests ordering cost is too low. If the frequency looks wrong, recheck those two inputs before trusting the lot size.
What holding cost rate should I use if I do not know it?: A common estimate is 15 to 30 percent of unit cost per year, covering cost of capital, warehouse space, insurance, and obsolescence. For a part costing $12, a 20 percent rate gives $2.40 per unit per year, the value in the example. Use the higher end for perishable or fast-obsolescing items and the lower end for cheap, stable commodities. Document your assumption so the EOQ is auditable.
Why does EOQ ignore minimum order quantities and pack sizes?: EOQ is a pure cost-optimization; it assumes you can order any quantity. Real constraints like supplier MOQs, case packs, truckload minimums, and shelf life are applied afterward. If EOQ is 894 but the supplier ships in cases of 250, round to 1,000 (four cases). Because the EOQ cost curve is flat near the minimum, that rounding adds only a small cost penalty, usually well under a few percent.
What is the difference between EOQ and reorder point?: EOQ answers how much to order; reorder point answers when to order. EOQ of 894 units sets the lot size and gives about 13 orders a year. The reorder point is the inventory level that triggers each of those orders, based on demand during lead time plus safety stock. They work together: reorder point fires the signal, and EOQ determines the quantity you release each time.