Effective inventory management is fundamental to any product-based business, yet this process can be a delicate balance for brands of all sizes. Since carrying inventory is inherently expensive, ecommerce companies need to be incredibly careful with their number of orders and how they stock their warehouse locations.
When managing inventory levels, some items will inevitably need to be scaled back, while others will likely merit reordering (to avoid lost sales). This ebb and flow can certainly present a challenge — but it’s one that economic order quantity is ready to tackle head on.
What is economic order quantity (EOQ)?
Economic order quantity (EOQ) refers to the optimal order quantity a company should purchase to meet demand and minimize expenses. The ideal amount of inventory can be found using an established formula that helps businesses lower their annual carrying costs, reduce warehousing fees, and prevent overstock or stockout situations. With the help of EOQ, brands can satisfy their customers’ needs, while also safeguarding their cashflow at the same time.
Calculate EOQ to increase cost efficiency
At its core, cost efficiency is all about saving money — something every business from every industry can undoubtedly get on board with. But to achieve cost efficiency and boost your profits, your company might need to make a few changes (or additions) along the way. By incorporating EOQ into your operational strategy, your brand can not only reduce its overall inventory costs, but improve its inventory forecasting and eliminate stockouts, as well.
Reduce inventory costs
Inventory costs for ecommerce sellers are commonly referred to as carrying, holding, or storage costs, all of which increase in proportion to the amount of inventory you have on hand. In other words, having too much stock sitting around in your warehouse can significantly impact your bottom line (since you’ll still have to pay unit costs on unsold items). But when you leverage your company’s unique EOQ, you can avoid having a surplus of stagnant goods, and instead store the right volume of SKUs to effectively meet consumer demand.
Increase inventory forecasting accuracy
When a company has too much or too little inventory at its disposal, there’s a good chance its profitability will start to suffer. For example, if there’s excess inventory at your warehouse, it can affect your inventory turnover ratio and create issues with your financial assets. On the other hand, if you don’t have enough inventory to fulfill all your orders, you’re also at risk of losing sales and disappointing customers. Fortunately, calculating EOQ increases the accuracy of demand forecasting, making it easier to maintain appropriate inventory levels at all times.
In general, inventory shortages are attributed to an unforeseen surge in demand — and yet, inadequate forecasting and inaccurate reporting have a tendency to prompt stockouts, too. By prioritizing EOQ, your company can better understand how much (and how often) to reorder, so stockouts no longer pose a threat to your supply chain. This is because economic order quantity offers greater visibility into your past, present, and potential stock counts to help you determine the most cost-effective product quantities to keep on your shelves.
3 factors to calculate EOQ accurately
Though not overly complicated, economic order quantity does have a few parameters around how it needs to be calculated. For the most accurate outcomes, the EOQ formula has to factor in annual demand, holding costs, and order costs associated with each purchase.
The term ‘annual demand’ describes the customer demand your company receives for a particular product each year. To verify demand rate for your own business, you can look into a range of historical data, like turnover ratio, reorder points, and even purchase orders. With these insights in tow, you’ll have a good idea of the number of units you’re selling year over year, which will then inform your EOQ calculations (and support their accuracy, as well).
Annual holding costs can occur as direct costs from storing your inventory, or as opportunity costs from retaining inventory rather than investing that money elsewhere. Before you can calculate your EOQ, you’ll need to know how much you’re spending on holding inventory units per year. To measure your holding costs, add together storage fees, employee salaries, opportunity costs, and depreciation costs, and then divide by the total value of yearly inventory.
Essentially, order costs define how much you’re spending per purchase; more broadly, order costs encompass all the expenses incurred to create and process an order with a supplier, such as preparing a purchase order or inspecting goods after they’re received. These costs play a big part in determining the economic order quantity of an item, since they contribute to total inventory costs and influence several important components of order fulfillment.
3 ways of calculating economic order quantity (EOQ)
When done correctly, economic order quantity can minimize the cost of ordering and holding inventory, thus helping your company preserve as much money as possible. Calculating your individual EOQ can happen one of three ways: using the economic order quantity formula, employing an EOQ calculator, or including EOQ metrics in your inventory management.
Manually calculate EOQ with the EOQ formula
Economic order quantity can be calculated with a financial formula that ensures the combination of ordering costs and carrying costs are minimized (which then lowers your cumulative inventory costs). To manually calculate EOQ, follow the formula: EOQ = square root of [2DO] / H.
In this sequence, D = demand, O = order costs, and H = holding costs. Keep in mind, however, this formula doesn’t account for interest or opportunity costs. These can be factored in using the current risk-free rate in the equation's denominator, multiplied by your holding costs.
Use an EOQ calculator for quick calculations
If you’re not a fan of manual calculations, you can opt for an economic order quantity calculator to compute your EOQ for you. These online calculators will still require you to plug in your annual demand, order costs, and holding costs, but then they'll run the numbers on your behalf.
Include EOQ calculation in your inventory management process
Another possibility for EOQ calculations is to include this as part of your existing inventory management process. By integrating the EOQ formula with your ongoing inventory strategies, you’re bound to uncover some cash savings that can be used on other investments.
How to use Skubana’s economic order quantity (EOQ) calculator
Of the three options for calculating your company’s EOQ, using the designated calculator is arguably the preferred method for most ecommerce retailers. With the aid of this calculator, you can simply input your pre-determined demand plus order and holding costs, and within just a click or two, you’ll have the EOQ answers you’ve been looking for.
Skubana’s (now Extensiv) economic order quantity calculator was created for easy accessibility and application, and can be trusted to export the most accurate and up-to-date EOQ details. By relying on Skubana’s handy EOQ calculator, your brand can save considerable time and money — two resources any and every company can benefit from having more of.
Make decisions based on past data trends
Speaking of sales patterns and historical order information, Extensiv supports companies in making forecasting and purchasing decisions based on their previous data trends. Using these insights, sellers can readily keep their products stocked, since Extensiv automatically updates key values like sales velocity, reorder quantities, and forecasted reorder dates. Better decisions translate to increased sales, smoother fulfillment, and a more satisfied customer base.