EOQ acts as a continuous review system, monitoring inventory nonstop and ordering a fixed quantity once inventory levels reach a specific reorder point. It gives retailers instant replenishment without any shortages or stockouts. Show
EOQ is a valuable inventory management tactic for small businesses because it helps you decide:
However, the EOQ model requires underlying assumptions in order to work:
Alvaro continues, “If you order a large number of products at one time, it will increase your business’s holding costs. But if you order fewer items, more frequently, it will reduce holding costs but increase order costs.” The EOQ model helps you plan an inventory system so you never run out of stock and keep customers happy with your brand. 5 Free Templates to Better Understand Your InventoryCalculate your businesses cost of goods sold, sell through rate, inventory turnover, saftey stock, economic order quantity, or reorder point with ease using these custom templates. (No math required!) Get your free templatesGet your Inventory Templates delivered right to your inbox.Almost there: please enter your email below to gain instant access. Email addressGet updates We'll also send you updates on new educational guides and success stories from the Shopify newsletter. We hate SPAM and promise to keep your email address safe. Thanks for downloading. You'll receive your free templates soon. In the meantime, start building your store with a free 3-day trial of Shopify.Get started Importance of calculating EOQReduce stockoutsRetailers miss out on $1 trillion every year due to stockouts alone. Selling out of a popular product could result in lost sales and lost shoppers, because they’ll go to another store to find the desired product. Determining EOQ is one of the most efficient ways to guarantee you’ll have enough stock available. 💡 PRO TIP: Ship-to-customer order fulfillment is the easiest way to prevent stockouts from hurting revenue. Rather than being limited to selling products you have in stock, you can sell products in-store and ship them to customers from your warehouse or another store location that has inventory. EOQ determines your business’s reordering point. When the stock drops below a certain level, your EOQ formula — when applied correctly — triggers the order for more units. That way, you avoid running out of inventory and can continue fulfilling orders. Avoid overstockingOverstocking is having more products than you can sell. Over-ordering inventory leaves you with too much product — a financial drain on your business. Storage fees are rising every year, so you need to optimize your inventory processes. The longer you hold stock, the higher the holding costs you’ll pay. EOQ, however, determines the middle ground between overstocking and understocking inventory. You’ll know exactly how much product will be ordered at certain inventory levels.
Improve cash flowEOQ not only helps you better plan inventory buys, it also increases cash flow for your business. Inventory is a retail business’s largest asset, other than labor, and you need ample inventory to meet customer demand. The EOQ formula keeps cash out of your inventory balance and in other productive areas. For example, if you run out of inventory, there’s a shortage cost, which equals revenue loss because you can’t fill orders. If EOQ can minimize inventory levels and lower holding costs while keeping stock constantly available, the extra cash can be used in areas like product development or marketing. The economic order quantity formulaThe EOQ formula is the square root of: [2(setup costs)(demand rate)] / holding costs Q= √2DS / H
To properly determine EOQ, you’ll need to determine holding costs. These costs refer to all costs involved in storing unsold inventory, including:
Use the following formula to determine inventory holding costs: Cost of Storage / Total Annual Inventory Value X 100 Example of calculating EOQLet’s say you run an electronics store called Geeky Gadgets. You need to purchase 10,000 drones per year to meet demand (D). You incur an order fee of $100 (S) and a holding cost of $15 (H) per drone. If you want to know your EOQ, you’ll plug those numbers into the formula: Q= √2DS / H EOQ = √2 X 10,000 X 100/15 = √133,333 EOQ = 365.14 So whenever Geeky Gadgets orders drones, they should order 366 of them, rounded up to the nearest whole unit. Challenges with economic order quantityBad dataA business must have the right data to make accurate calculations. EOQ assumes there’s a steady demand for products, and that you can replenish products immediately. It also assumes fixed costs for:
This makes it hard, or nearly impossible, for businesses to account for changes in consumer demand or seasonality. If you don’t have correct, real-time data on holding or order costs, you’ll have the wrong amount of inventory, which can quickly lead to a stockout. Determining the correct amount of inventory requires you to estimate needs based on historical demand. This can be time-consuming if you’re using spreadsheets and have no tracking in place. Inventory management software, however, can pull this information together in a few clicks, so you can apply the right data to your EOQ formula. Unlock new opportunities with Shopify Only Shopify POS integrates your online and retail store data into one easy-to-understand back office. Spot trends faster, capitalize on opportunities, and run your business with confidence. Email addressStart free trial Seasonality and changing demandThe EOQ model is a simple model for products with consistent demand throughout the year. But this isn’t always the case. Newly launched products may have higher demand in the beginning that decreases over time. Products with seasonal demand — in which sales fluctuate throughout the year — could invalidate EOQ calculations. You can’t simply measure EOQ at the beginning of the year and expect it to hold true. This could lead to periods of stockouts or excess inventory because of inconsistent reordering. “Every product you have on hand will have a unique EOQ depending on its demand, so there is no blanket order quantity that you can apply across your inventory,” explains Hodge. She continues, “Seasonality will play a role and demand often shifts over time, so maintaining accurate EOQs requires constant demand and turnover rate monitoring.” Hodge has managed a storefront for several years, working in merchandising, buying, and sales analysis. She describes a common issue faced by many retailers: “In my boutique, we had a best-selling top that we sold in large quantities for years,” she says. “However, it was long-sleeved, so it was never as popular during the summer months, and it tended to sell better in neutral as opposed to bright colors. Using sales and inventory data from our point-of-sale (POS) system, we were able to pick up on these trends quickly and adjust our order quantities accordingly.” Hodge says that nailing down when and how demand for her best-selling top “fluctuated with our customer base allowed us to determine the ideal EOQ of our bestseller, ensuring we always had it in stock for our customers and weren't left with excess in our stock rooms in slower seasons.” Learn more: How to Forecast Demand for Your Retail Store (and Why You Should) Supply shortagesAnother limitation of the EOQ model is potential inventory shortages. Some businesses new to using EOQ can be conservative in their reordering, which results in smaller orders and being left understocked in your store. Related: What is Safety Stock and How Much Do I Need For My Store? Calculate EOQ for your storeMismanaged inventory is a supply chain nightmare for any retailer. It can lead to understocked stores, lost revenue, and — worst of all — unhappy customers who never return. Use the EOQ model to order the ideal amount of inventory for your store. Run the formula on your in-demand SKU numbers, and check predictions against previous ordering data. You’ll soon start to see the benefits of more cash flow and fewer stockouts using the EOQ model. Manage inventory from one back office Shopify POS comes with tools to help you manage warehouse and store inventory in one place. Forecast demand, set reorder points, get low stock alerts, create purchase orders, know which items are selling or sitting on shelves, count inventory, and more. Email addressStart free trial About the authorMichael Keenan Michael is a SaaS Marketer and SEO and founder of Peak Freelance. He’s inspired by learning people’s stories, climbing mountains, and traveling with his partner and two Xoloitzcuintles. Topics: Inventory Management Grow your retail businessGet exclusive behind-the-scenes merchant stories, industry trends, and tips for creating standout brick-and-mortar experiences. Which of the following is not an assumption of the basic economics order quantity model?∴ So, stochastic demand is not an underlying assumption of the basic EOQ model.
What are the assumptions of the basic economic order quantity model?The EOQ model assumes that demand is constant, and that inventory is depleted at a fixed rate until it reaches zero. At that point, a specific number of items arrive to return the inventory to its beginning level. Since the model assumes instantaneous replenishment, there are no inventory shortages or associated costs.
Which of the following is not an assumption of economics?Answer and Explanation: All of the given choices are economic assumption in the process of developing a production possibilities frontier (PPF) except the assumption that the society will always be producing somewhere on the PPF.
Which of the following is not true about EOQ inventory model?Run size exceeds maximum inventory is not true about the EOQ model. Explanation: EOQ model is also referred to as the production lot size or the non-instantaneous gradual model. In the economic order quantity model, the rate of consumption and replenishment is not the same.
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