The basic Economic Order Quantity (EOQ) formula is as follows:
EOQ = √ (2 × (Annual usage in Units) × (Order Cost)) / ((Annual carrying Cost per Unit))
This formula means:
- The annual usage in units is generally the easiest part of the equation. It is the forecasted annual usage demand;
- The order or purchase cost is the sum of the fixed costs that are incurred every time an item is ordered. These costs are associated with the physical activities required to process the order. For the most part, order cost is primarily the labour associated with processing the order; however, you can include the other costs such as the costs of phone calls, faxes, postage, envelopes, etc;
- The stock-holding cost is that associated with having inventory on hand. It is primarily made up of the costs associated with the inventory investment and storage cost. For the purpose of the EOQ calculation, if the cost does not change based upon the quantity of inventory on hand it should not be included in carrying cost. In the EOQ formula, carrying cost is represented as the annual cost per average on hand inventory unit.
