Definition of Economic Order Quantity
When starting a business or placing your feet in the finance world, certain tools prove to be very useful to keep a track of your spendings and earnings. One such tool is economic order quantity. Economic order quantity or EOQ is the order quantity which is considered to be ideal for a company to purchase that helps reduce the holding costs and order costs for the company.
What is the importance of Economic Order Quantity?
Economic order quantity is the ideal amount at which you should purchase an item to maintain the most cost efficient supplies. This helps the companies to set an optimum number to the products that are to be ordered and not exceed that number.
If the company can achieve the above, it helps them to minimise the inventory costs like the holding and order costs, the delivery and supply costs, etc. Keeping the inventory cost in check is highly important for the companies as it provides a sense of security to the company and the cash savings in this form can be used for a number of purposes.
Economic order quantity is best used in companies where the demand, storage and order costs remain constant through longer periods of time. This is because Economic order quantity has a limitation that it considers that the company’s demand for products remain same over a long period of time.
How is Economic Order Quantity calculated?
Economic order quantity is calculated by using a formula which is formed by taking into consideration the demand, holding cost and the order cost. The EOQ formula is as follows:
EOQ = SQUARE ROOT OF (2 * D * S/H) OR √ (2DS/H)
Where, D = demand S = order cost H = holding cost
Economic Order Quantity is very important for companies as they help the companies to keep their inventory costs in check and manage them efficiently.
