Economic order quantity (EOQ), explained simply
Economic order quantity (EOQ) answers one question: how big should each order be? Order too little and you pay to reorder constantly. Order too much and you pay to hold the excess on a shelf. EOQ is the order size that sits in the middle and minimizes the combined cost of the two.
The core idea
Every order has two competing costs. Placing an order costs you something each time (paperwork, shipping, receiving time), so fewer, larger orders look cheaper. But holding stock also costs you (storage, capital tied up, spoilage), so smaller, more frequent orders look cheaper. EOQ finds the order size where these two costs balance and total cost is lowest.
The formula
EOQ = √(2DS / H)
- D = annual demand in units (how many you sell or use per year).
- S = cost per order (the fixed cost of placing and receiving one order).
- H = annual holding cost per unit (what it costs to keep one unit in stock for a year).
In words: EOQ is the square root of (2 × D × S, divided by H). Bigger demand or pricier ordering pushes the quantity up; pricier holding pushes it down.
A worked example
Say you sell 2,400 units a year (D), each order costs $30 to place (S), and holding one unit for a year costs $4 (H). Then:
EOQ = √((2 × 2,400 × 30) / 4) = √(144,000 / 4) = √36,000, which is about 190 units
So roughly 190 units per order is your sweet spot. With annual demand of 2,400, that works out to about 13 orders a year, or one every four weeks or so.
“How much” vs “when”
EOQ tells you how much to order. It does not tell you when. That is the job of your reorder point: the stock level that should trigger the next order. The two work together: the reorder point fires the order, and EOQ sets its size. Your reorder point also depends on the buffer you carry, so it is worth pairing this with safety stock.
Limits and assumptions
EOQ assumes steady demand and stable costs, which is rarely perfectly true. Treat it as a starting point, not a rule. Adjust it for bulk discounts (a bigger order may unlock a lower unit price), supplier minimum order quantities, and shelf life (perishable or fast-changing stock favors smaller, more frequent orders). If demand swings through the year, revisit your inputs alongside seasonal demand rather than trusting one annual average.
Where to get your numbers
The hard part of EOQ is not the math, it is good inputs. Your transaction history gives you annual demand (D). Your order history shows what each order actually costs to place and receive (S), and the unit values behind it feed your holding cost (H). Because larger orders tie up more cash on the shelf, it also helps to read EOQ next to your working capital.