Economic Order Quantity (EOQ)

Notes by Sachin Education Hub

(By Sachin Arora)

What is EOQ (Economic Order Quantity)?

EOQ is the ideal order quantity a company should purchase each time it places an order, so that the total cost of inventory (ordering cost + carrying cost) is minimized.

In simple words:

EOQ helps decide “how much to order at once” to reduce total inventory cost.

By Sachin Arora

Concept of EOQ

Whenever a company buys inventory (raw material, goods, components), it faces two types of costs:

1. Ordering Costs (Purchase related costs)

• These are the costs of placing and receiving an order.
• Examples: paperwork, transportation, communication, inspection, administrative costs.
• Ordering cost decreases if order quantity increases (because you place fewer orders).

NOTES BY SACHIN ARORA 

2. Carrying Costs (Holding costs)

• These are the costs of holding inventory in storage.
• Examples: warehouse rent, insurance, depreciation, spoilage, interest on blocked capital.
• Carrying cost increases if order quantity increases (because you hold more inventory for longer).

Trade-off: If you order very frequently (small quantity each time) → ordering cost is high but carrying cost is low. If you order very rarely (large quantity each time) → ordering cost is low but carrying cost is high.

NOTES BY SACHIN ARORA 

EOQ finds the balance point where both costs together are minimum.

• The ordering cost curve slopes down as order size increases.
• The carrying cost curve slopes up as order size increases.
• The total cost curve is U-shaped.
• Where ordering cost = carrying cost is the EOQ point → minimum total cost.

SACHIN EDUCATION HUB  (SACHIN ARORA)

EOQ Calculation:

A = Annual Demand of raw material

O = Order Cost per unit

C = Carrying Cost p.a. (Holding Cost)

Carrying Cost if % is given then:

CC = Cost per unit * %

Carrying Cost (other formula)

CC = Storage Cost + Opportunity Cost + Insurance Cost.

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Regards:

Sachin Arora

Owner – Sachin Education Hub