Summary
This article walks through what Economic Order Quantity (EOQ) is, how it is calculated and where it is used.
Applies To
All Items with Order Policy as Order Point
Process
Economic Order Quantity (EOQ) is the calculated quantity of an item that is most cost-effective to buy, based on usage, ordering costs, your percent holding cost, and the cost of the item. EOQ for an item is used to prevent ordering an item too often, or too infrequently.
EOQ is based on the following factors:
- Daily Usage: Average daily out to the leadtime of the part (today + leadtime days). Higher usage means you need to order larger quantities at a given time.
- Cost: Higher cost means that you want to order the item in smaller quantities.
- Incremental Cost Of Ordering (ICO): This takes into account your costs related to ordering, from Economic Order Manager's Set EOQ Screen. If it costs you more to order and receive, you'll want to order larger amounts. This is calculated according to a worksheet in your EOQ Settings page.
- Percent Holding Costs (THC): If your holding costs are high, you will want to order smaller quantities. This is calculated according to a worksheet in your EOQ Settings page.
- Workdays Per Year: Workdays per year varies on if your location is open Saturdays and/or Sundays. This is only used to convert your annualized values to daily values in the EOQ calculation.
EOQ is calculated as follows:
EOQ = sqrt( (2 * ICO * dailyUsage * WorkdaysPerYear) / (cost * THC) )
There are also additional empirical tests run on your EOQ calculation, such as checking for large forecast drops in the near future, as well as practicality limits for items with no price or cost information.
Forecast Dropoff Check
After this initial calculation is done, the minimum and maximum months-worth caps are applied to the calculated EOQ. Starting at lead time (aka the soonest an order placed today could arrive), StockIQ also checks for usage changes in the future, out to the number of months specified in the maximum days of EOQ.
For example, if a 1 month of supply maximum EOQ was specified, StockIQ would check forecasted usage 1 month out, starting from lead time. If the sum of all forecast over the next month is less than the currently calculated EOQ, indicating a large drop in forecast, the EOQ is re-capped at that lower level.
Coupled with a safety stock that will be declining at this time, this will help you have as little leftover product as possible for when an item is either reaching end of life, or simply coming out of season.
Bonus: Vendor-Level EOQ
The concept of an EOQ at the vendor level can be configured for helping to determine order cycles.
The same inputs to the calculation are used, except that the cost is a volume-weighted average cost across all parts purchased from that vendor. This means that items which have higher usage have a larger input into the average cost calculation. After a vendor level EOQ is obtained, an order cycle can be obtained by dividing that EOQ by the average total usage at that vendor, resulting in a number of days.