Definition of EOQ
EOQ is the acronym for economic order quantity. The economic order quantity is the optimum quantity of an item to be purchased at one time in order to minimize the combined annual costs of ordering and carrying the item in inventory.
EOQ is also referred to as the optimum lot size.
The formula to calculate the economic order quantity (EOQ) is the square root of [(2 times the annual demand in units times the incremental cost to process an order) divided by (the incremental annual cost to carry one unit in inventory)].
Example of EOQ Calculation
Assume that a company has steady demand of 12,000 units per year for one of its products. The company purchases the product from its supplier at a cost of $100 each. The company’s incremental cost to process an order is $144 and its incremental annual cost to carry the product in inventory is $16 per unit.
EOQ = the square root of [(2 X 12,000 units of annual demand X $144 the incremental cost to process an order) / $16 the incremental annual cost to carry one unit in inventory] = the square root of [(2 X 12,000 X $144) / $16] = the square root of [$3,456,000 / $16] = square root of 216,000 units = 465 units (rounded to a whole unit).
