Economic order quantity: Definition, formula, and examples

Managing inventory is a balancing act. Order too much, and you tie up cash in excess stock. Order too little, and you risk stockouts that disrupt operations. Economic order quantity (EOQ) helps businesses find the sweet spot—ensuring they order just enough to minimize costs while meeting demand.

What is EOQ?

First introduced by Ford W. Harris in 1913, EOQ is still widely used in industries such as retail, manufacturing, and e-commerce. It helps businesses avoid overstocking costs by guiding them to smarter ordering decisions.

Understanding economic order quantity in inventory management

Efficient inventory management means keeping just the right amount of stock. It should be enough to meet demand without overspending on storage or frequent reorders. Economic order quantity (EOQ) helps businesses achieve this by calculating the ideal order size that minimizes both ordering costs (like processing and shipping) and holding costs (like warehousing and depreciation).

This model is especially useful for businesses managing high inventory turnover. For example, retailers lose millions of dollars annually due to poor inventory planning, including overstocking and stock shortages.

If they order too much at once, they tie up cash in excess stock that takes months to sell. EOQ helps solve this by setting an order size that ensures products are available without overloading storage.

This formula-driven approach improves efficiency across industries. Manufacturers use EOQ to optimize raw material purchase orders, ensuring production runs smoothly without costly overstocking. E-commerce businesses rely on it to avoid stockouts, keeping fulfillment seamless without overloading warehouses.

Integrating EOQ into inventory management helps businesses reduce waste, improve cash flow, and avoid costly supply chain disruptions. It’s a simple yet powerful tool for making smarter ordering decisions.

Key assumptions of EOQ and their implications

The economic order quantity (EOQ) model is built on a set of assumptions designed to simplify inventory management and create a predictable ordering process. These assumptions allow businesses to calculate an ideal order size without factoring in every possible variable, making EOQ a useful starting point for inventory decisions.

1. Demand remains constant throughout the year

EOQ assumes that businesses sell the same number of units each month, making it easy to determine when to reorder. This assumption simplifies planning by removing the need to adjust for seasonal or unexpected changes in demand.

However, most businesses experience fluctuations due to seasonal trends, promotions, and market shifts. To keep EOQ accurate, companies should regularly update their calculations and use demand forecasting tools to adjust for market trends.

2. Inventory is replenished instantly

EOQ assumes that inventory arrives immediately after an order is placed, preventing stockouts. This assumption removes the complexity of supplier lead times, making calculations more straightforward.

However, in reality, suppliers take time to fulfill orders, and delays can occur due to production bottlenecks, shipping issues, or supply chain disruptions. Over 80% of businesses experience supply chain delays annually, which can result in stock shortages if EOQ does not account for lead times.

To avoid this risk, businesses should factor in supplier lead times when setting reorder points and maintain a buffer stock to cover unexpected delays.

3. Ordering and holding costs remain constant

EOQ assumes that the cost of placing an order and the cost of storing inventory do not change over time. This assumption makes comparing the trade-offs between ordering frequently and holding more stock easier.

However, real-world costs fluctuate due to inflation, warehouse space constraints, and supplier pricing changes. For example, if a supplier increases shipping fees or a company’s warehouse reaches capacity, the original EOQ calculation may no longer be cost-effective. Businesses should review their costs regularly and adjust EOQ as expenses change.

With Ramp’s AI-powered transaction categorization, a manufacturing company can track how supplier pricing changes over time. Ramp automatically updates financial reports if material costs increase, allowing the finance team to adjust EOQ accordingly. This prevents businesses from ordering based on outdated cost assumptions.

4. No stockouts or shortages occur

The EOQ model assumes that inventory is always available when needed, meaning businesses never run out of stock. This assumption simplifies inventory planning by removing the need to account for lost sales, emergency orders, or rush shipping costs.

However, stockouts are a common and costly problem. U.S. retailers lose over $349 billion annually due to inventory shortages. If EOQ is used without considering potential stockouts, businesses may not have enough inventory to meet sudden increases in demand.

To prevent this, companies should maintain a buffer stock and adjust EOQ when demand is unpredictable.

5. No quantity discounts apply

EOQ calculations assume that ordering larger quantities does not reduce the price per unit. This makes the formula simple because it only balances ordering costs and holding costs without factoring in bulk pricing.

However, many suppliers offer volume discounts, where larger orders result in lower costs per unit. Ignoring these discounts can lead to higher expenses than necessary, as a strict EOQ approach may suggest smaller orders even when ordering in bulk would be more cost-effective.

Businesses should compare their EOQ-based costs with supplier discount structures to determine whether a larger order quantity would lead to greater savings.

6. EOQ applies to a single product at a time

EOQ is designed to calculate the ideal order quantity for one product, assuming that businesses manage each product separately. This assumption makes inventory accounting and planning easier, as businesses can optimize stock levels for each item without considering how other products affect costs.

However, most companies handle multiple SKUs, and ordering different products together can impact shipping, storage, and supplier pricing. A business ordering multiple products from the same supplier may benefit from combining orders to save on shipping fees or take advantage of bulk discounts.

Companies managing large inventories should use EOQ alongside inventory management software to ensure they are optimizing orders across multiple products.

Economic order quantity formula

The economic order quantity (EOQ) formula calculates the ideal order size that minimizes total inventory costs. It balances two key expenses: ordering costs (expenses for placing and receiving orders) and holding costs (costs of storing unsold inventory levels).

The EOQ formula is:

EOQ = √(2DS / H)​​

Here:

• D = Annual demand rate (unit cost per year)
• S = Ordering cost per order (setup costs, admin fees, shipping)
• H = Holding cost per unit per year (storage, insurance, depreciation)

This formula helps businesses avoid unnecessary expenses and optimize stock levels.

For example, if a company sells 10,000 units per year, pays $50 per order, and has a holding cost of $5 per unit, their EOQ would be:

EOQ = √(2 (10,000) (50) / 5)​​ = 447 units

This means ordering 447 units at a time keeps costs at a minimum. Ordering in smaller or larger batches would increase expenses due to excessive ordering or high storage costs.

A company using EOQ to optimize raw material purchases needs to know if supplier costs fluctuate. Instead of relying on outdated spreadsheets, Ramp syncs directly with NetSuite or QuickBooks, ensuring the latest purchasing costs feed into EOQ calculations. This prevents businesses from using outdated or incorrect cost data that could lead to over-ordering or unnecessary expenses.

How to calculate EOQ for your business?

Economic order quantity (EOQ) is typically calculated by inventory managers, operations teams, and finance departments to optimize purchasing decisions. Businesses that rely on steady inventory flow, such as manufacturers, retailers, and e-commerce companies, use EOQ to control costs and avoid inefficiencies.

Step 1: Gather the required data

To calculate EOQ, businesses need three key figures: annual demand, ordering cost per order, and holding cost per unit per year.

Annual demand represents the total number of units a company expects to sell in a year. Ordering costs include all expenses tied to placing an order, such as administrative fees, supplier charges, and shipping costs. Holding cost accounts for the cost of storing unsold inventory, including warehousing fees, depreciation, and insurance.

Step 2: Apply the EOQ formula

Once the data is collected, businesses use the economic order quantity (EOQ) formula to determine the optimal order size. The formula states that EOQ is found by:

Taking the square root of twice the annual demand, multiplied by the ordering cost per order, and then dividing that by the holding cost per unit per year.

In simpler terms, EOQ helps businesses balance the cost of ordering inventory with the cost of storing it. This calculation allows companies to determine the most efficient quantity to order each time, minimizing total inventory costs.

Step 3: Adjust for real-world constraints

The EOQ formula provides an ideal order quantity under stable conditions, but real-world challenges often require adjustments.

Businesses may need to modify EOQ if bulk order discounts make larger procurements more cost-effective. Limited warehouse space may force companies to lower their order size. Seasonal businesses may adjust EOQ several times a year based on demand fluctuations. Additionally, supplier-imposed order minimums or maximums can restrict a business’s ability to follow EOQ exactly.

Step 4: Monitor and refine EOQ regularly

Businesses don’t just calculate EOQ once and forget about it. Market trends, supplier pricing, and operational costs change over time, requiring companies to reassess EOQ periodically.

Some companies review EOQ every quarter, while others update it only when major shifts in demand, storage costs, or supplier terms occur. With inventory mismanagement costing businesses millions of dollars annually, fine-tuning EOQ ensures companies minimize waste, avoid stockouts, and improve cash flow.

What does economic order quantity (EOQ) tell businesses?

Some companies review their economic order quantity quarterly or annually, while others adjust it more frequently based on seasonal demand, supplier pricing changes, or shifts in storage capacity. Companies with high inventory turnover or fluctuating demand tend to recalculate EOQ more often to keep ordering strategies aligned with real-world conditions.

It helps companies determine how much to order at a time to minimize total costs while keeping stock levels optimized.

• The optimal order quantity to reduce costs. EOQ balances ordering costs (like administrative fees and shipping) with holding costs (such as storage and depreciation). Instead of guessing how much stock to buy, businesses get a data-backed quantity that balances supply with demand. This prevents excessive storage costs and unnecessary reordering.
• How often you should reorder inventory. EOQ helps businesses decide the best ordering frequency to avoid excessive costs. A company ordering too often may pay unnecessary shipping and processing fees, and ordering too infrequently can lead to stock shortages. EOQ provides a structured approach to maintaining a steady inventory flow without unnecessary expenses.
• How to align inventory with demand. A business that frequently runs out of stock or holds too much inventory likely has an inefficient ordering strategy. EOQ identifies whether companies need to adjust their order quantities or reorder timing to match real customer demand. This is especially critical in retail, e-commerce, and manufacturing industries, where overstocking or stockouts can lead to lost revenue and high operational costs.
• How to improve supplier relationships. Consistent ordering patterns allow businesses to negotiate better terms, reduce rush orders, and strengthen supplier relationships. A predictable purchasing schedule makes it easier for suppliers to plan production, which can lead to bulk discounts, priority fulfillment, or lower shipping costs.
• How to adapt ordering strategies for changing conditions. While EOQ assumes stable demand and fixed costs, businesses can adjust their ordering strategies based on real-world factors. If a company faces seasonal demand changes, supply chain disruptions, or bulk order discounts, EOQ serves as a starting point for modifying order quantities to fit business needs.

Making smarter inventory decisions with EOQ

Economic order quantity (EOQ) is a strategic tool that helps businesses manage their inventory more effectively. By calculating the optimal order size, companies can reduce costs, minimize waste, and maintain steady stock levels without overordering or underordering.

But EOQ isn’t a set-it-and-forget-it number. Businesses that review and refine their EOQ based on demand fluctuations, supplier changes, and storage capacity make the smartest inventory decisions.

EOQ helps companies free up cash flow, negotiate better supplier terms, and improve operational efficiency when used effectively. It prevents businesses from tying up capital in excess inventory while ensuring they never lose sales due to stockouts.

Businesses using Ramp’s real-time expense tracking and automated categorization no longer have to manually reconcile supplier payments or warehouse costs before calculating EOQ. Instead, financial data syncs automatically, ensuring every EOQ adjustment is based on the latest purchasing trends and cost changes. This allows businesses to reduce waste, negotiate better supplier terms, and avoid cash flow issues caused by inefficient ordering.