Cost Accounting

Economic Order Quantity in Manufacturing: When Buying More Costs Less

EOQ equals the square root of 2 times annual demand times ordering cost divided by annual holding cost per unit. Here is how to use it.

EOQ, or economic order quantity, = square root of (2 x annual demand x ordering cost divided by annual holding cost per unit). For a part with annual demand of 10,000 units, ordering cost of $85, and annual holding cost of $4.50 per unit, EOQ = square root of (2 x 10,000 x 85 divided by 4.50) = about 615 units. That order size minimizes the combined cost of placing orders and carrying inventory. The formula matters because buying larger lots to get a lower piece price can still raise total cost. EOQ gives purchasing and planning a defensible starting point instead of guessing between too many small POs and one oversized buy.

The key inputs are annual demand, ordering cost per order, and annual holding cost per unit. Ordering cost should include buyer time, receiving, inspection, AP processing, and any expedite work, while holding cost should include capital, storage, handling, insurance, and obsolescence risk. In manufacturing, holding cost is often estimated at 20% to 30% of unit value per year, so an $18 part at a 25% carrying rate has H = $4.50. Using 20% versus 30% changes EOQ by about 22%, so the assumption matters. Actual values should come from purchasing process studies, warehouse cost data, and finance carrying-rate policy, not from a generic textbook example.

The most common mistake is leaving out real ordering cost and then concluding that very small orders are efficient. If a buyer spends 90 minutes per order at a loaded $40 per hour and receiving plus AP add $35, the true ordering cost is already about $95 before any expedite premium. Another error is applying EOQ blindly when supplier MOQ, shelf life, storage capacity, or quantity discounts dominate the situation. Teams also forget that demand is not constant, so an EOQ built from one annual average can be wrong for strongly seasonal items. EOQ is a model, not a substitute for plant reality.

Use the result to set a rational default order size, then compare it against supplier breaks, MOQ, and available space. If a discount is offered above EOQ, calculate total annual cost at the breakpoint and compare it with total cost at EOQ rather than assuming the lower unit price wins. EOQ also helps explain why reducing order processing effort matters, because lower ordering cost pulls EOQ down and frees cash tied up in inventory. That makes procurement automation, receiving simplification, and vendor-managed inventory easier to justify. The number should feed into replenishment policy, not live only in a training deck.

Advanced users pair EOQ with reorder point, service level, and demand classification. Stable A and B items usually fit EOQ logic well, while slow movers, intermittent spare parts, and highly seasonal items may need periodic review or lot-for-lot planning instead. Review EOQ whenever demand changes materially, carrying rates move, or supplier terms are renegotiated. The best inventory policies combine EOQ for lot size, reorder point for timing, and ongoing review of actual turns and stockouts. That combination keeps EOQ in the real operating system instead of as a one-time classroom exercise.

Published 2026-05-28.