Economic order quantity (EOQ) code

The optimal stock-on-hand quantity is calculated when you define the EOQ code. For example, a large appliance wholesaler sells refrigerators that are expensive to stock, but relatively inexpensive to order. The Economic Order Quantity calculation provides an optimal stock-on-hand quantity for refrigerators. The quantity suggested is low because it is less expensive to frequently order small quantities of refrigerators than to stock large quantities.

Use a reorder quantity code of Economic Order Quantity so that the method of reordering items is most cost effective. The Economic Order Quantity code uses a calculation to balance the cost of ordering against the cost of stocking an inventory item. To use the Economic Order Quantity code, you must choose automatic purchasing for the item location. The code is available with either of the reorder policies, Fixed Order Point or Time-Phased Order Point.

The Economic Order Quantity is the quantity that is required on a purchase order when the stock-on-hand for an item falls below the reorder point set at the item location. You can create the Economic Order Quantity manually or run a batch program to perform the calculation, Economic Order Quantity and Reorder Calculation . The Economic Order Quantity calculation uses this formula:

EOQ = square root of [(2 times the annual demand quantity x the fixed order preparation cost) / (the carrying item unit cost)

Note: The calculation provided by the EOQ formula replaces the reorder point for an item only if you define EOQ as the reorder quantity and update the reorder point when you run Economic Order Quantity and Reorder Calculation.

These are some considerations to note about the formula:

  • The annual demand quantity is the item quantity that you expect to have in the warehouse over a year's time. This means the quantity that comes into the warehouse while the item continues to be consumed from its location. The quantity can come from past demand, from past demand with this year's expected demand, or from firm orders. Be aware that the annual demand quantity and the carrying item unit cost must be in the same unit of measure.
  • The fixed order preparation cost is the cost that does not change with an order's size. For example, these costs can include order research and administration, costs for picking and shipping, and prorated maintenance fees for software and hardware. The possible sources for these fixed costs are labor figures and general ledger accounts. Variable costs, such as the cost of picking, packing, and shipping, should not be included.
  • The carrying item unit cost represents the cost of doing business: paying for rent and insurance, utilities, spoilage, and so on. These costs are what is required so that you can stock the items at the warehouse.