What economic order quantity solves
Ordering inventory involves two costs that pull in opposite directions. Order too often in small batches, and you pay repeated ordering costs (supplier minimums, shipping, staff time processing each PO). Order too rarely in large batches, and you pay more in carrying cost—warehouse space, tied-up cash, insurance, and the risk of the stock going stale before it sells.
EOQ is the order quantity that sits at the point where those two costs are balanced—minimizing the total of both rather than optimizing either one alone.
The EOQ formula, with a worked example
EOQ = √(2 × Annual Demand × Order Cost ÷ Carrying Cost per Unit per Year).
Example: a product sells 6,000 units a year, costs $50 to place each order (staff time plus shipping), and costs $2 per unit per year to carry in the warehouse. EOQ = √(2 × 6,000 × 50 ÷ 2) = √300,000 ≈ 548 units per order. Ordering roughly 548 units at a time, rather than smaller or larger batches, minimizes the combined ordering and carrying cost for that item over the year.
- Annual demand: total units sold or used per year
- Order cost: the fixed cost of placing one order, regardless of size
- Carrying cost per unit: the annual cost of holding one unit in stock
When EOQ does not apply cleanly
The classic EOQ formula assumes steady, predictable demand and a fixed order cost—assumptions that hold reasonably well for stable staple items, but break down for seasonal products, items with volume-based supplier discounts, or perishable goods with a shelf-life limit shorter than an EOQ-sized batch would sit on the shelf.
Treat EOQ as a starting reference for stable, steadily-selling SKUs rather than a fixed rule for the whole catalog—items with irregular demand or expiry constraints usually need a judgment call layered on top of the raw formula.