Economic order quantity: the formula, and when a small store can ignore it
Economic order quantity, or EOQ, is the order size that makes the combined cost of ordering and holding stock as low as it goes. The formula is EOQ equals the square root of two times annual demand times cost per order, divided by holding cost per unit per year.
The formula, and what each input means
Economic order quantity is the order size that makes the combined cost of ordering and holding stock as low as it goes. Written out:
EOQ = square root of ( (2 x D x S) / H )
Three inputs, and only three:
- D, annual demand in units. How many units of this one SKU you expect to sell in a year. Not revenue, not cases, units.
- S, cost per order. What it costs you to place one purchase order, whatever the size: the admin time, the fixed freight, the inspection and put-away at the other end.
- H, holding cost per unit per year. What one unit costs you to keep on a shelf for a year: the cash tied up in it, the storage, the shrink and the markdown risk.
The output is a quantity, not a date. EOQ answers how much to buy. It says nothing about when, which is the question most merchants are actually asking when they go looking for inventory formulas.
A worked example on one SKU
Take a candle that sells steadily. You expect 1,200 units over the year. Each purchase order costs you roughly $40 to place once you count the time and the fixed freight. Holding one unit for a year costs about $3.
- 2 x 1,200 x 40 = 96,000
- 96,000 / 3 = 32,000
- square root of 32,000 = 178.9
So EOQ is about 179 units, or roughly seven orders a year. Order in 50s and you pay the $40 ordering cost twenty four times. Order 600 at a time and you sit on half a year of candles.
Notice how much weight sits on two numbers you estimated. Double your guess at ordering cost and EOQ only rises by about 41 percent, because of the square root. That flatness is the formula's real gift: around the bottom of the cost curve, being roughly right is close enough. Ordering 150 or 200 instead of 179 barely moves your total cost.
What the formula assumes, and what a small store actually faces
| The formula assumes | What a 50 to 2,000 SKU store deals with |
|---|---|
| Demand is steady and known for the year | A launch, a gifting season or a creator mention moves a SKU by multiples in a week |
| You can order any quantity you like | Minimum order quantities, case packs of 12 or 24, and pallet breaks |
| Each SKU is ordered on its own purchase order | One supplier ships forty of your SKUs on one order, so the ordering cost is shared |
| Ordering cost is a knowable fixed number | It is mostly your own time, and it changes depending on how busy the week is |
| Holding cost per unit is knowable | Storage is your spare room or a 3PL line item, and cash is the real constraint |
| Stock arrives instantly when ordered | Lead time is two weeks, or sixty days by sea |
When a small store can ignore it
Ignore EOQ when the supplier has already decided for you. A case pack of 24 and a minimum of 100 leave you with two legal order sizes, and no formula is going to pick a third. The same goes for a free-shipping threshold, which is just an ordering cost with a cliff in it.
Ignore it when ordering is cheap. If placing an order means replying to an email you were going to send anyway, S is close to zero, and the formula pushes you toward ordering little and often, which is what you were doing already.
Ignore it when the SKU moves erratically. D is an annual average, and an average is a poor description of a product that sells nothing for eight months and two hundred units in December.
Use it when the stakes are real: a SKU with high volume, a supplier who charges a per-order fee or a freight minimum, and cash that could be working on something else. That is a handful of your catalogue, not all of it.
And be clear about what you are solving. Running out of stock on a seller is a straight financial hit, and EOQ does nothing to prevent it. The number that prevents it is the reorder point: the stock level at which you place the order, set from how fast the SKU sells and how long your supplier takes. Get the trigger right first, then argue about the size of the order.
Related terms
EOQ sits alongside five numbers that matter more day to day for a small catalogue. Each has its own page in this glossary.
- Reorder point. The stock level that triggers the order. The formula worked through on a real SKU.
- Sales velocity. Units per day, and why a 7, 14 or 30 day window gives three different answers for the same product.
- Lead time. The gap between placing the order and the stock being sellable. The one input no app can read from your store.
- Safety stock. The buffer that absorbs a slow supplier or a good week, and how merchants size it without a statistics degree.
- Days of inventory on hand. Current stock divided by daily sales, read as runway rather than as a count.
- Stockout. What running out actually costs a small store, counted properly.
There is also a guide on turning velocity and lead time into an order date, and a worked case for suppliers sixty days away.
Questions
What is the economic order quantity formula?
EOQ equals the square root of (2 x D x S) divided by H, where D is annual demand in units, S is the cost of placing one order, and H is the cost of holding one unit for one year. The result is a quantity to order each time.
What is the difference between EOQ and the reorder point?
EOQ tells you how much to order. The reorder point tells you when to order, and it is built from sales velocity and lead time rather than from costs. A store can run well on reorder points alone, but not on EOQ alone.
How do I work out my cost per order?
Add up what one purchase order costs you regardless of its size: the time spent raising and chasing it, any fixed freight or handling charge, and the receiving work at your end. If one order covers many SKUs from the same supplier, split that cost across them, or accept that EOQ per SKU will overstate the order size.
How do I work out holding cost per unit?
Take the cost of the unit, apply a rate for the cash tied up in it, then add storage, insurance, shrink and the markdown risk for a year. Many small stores land somewhere between a fifth and a third of unit cost per year. Because of the square root, being approximately right is usually good enough.
Does EOQ include safety stock?
No. EOQ sizes the order. Safety stock is a buffer that sits inside the reorder point to cover demand spikes and late deliveries. They are separate decisions and both can be used together.
What if my supplier has a minimum order quantity?
Then the minimum usually wins. Calculate EOQ anyway as a sanity check: if it comes out well below the minimum, you know you are carrying more stock than the maths wants and the cash cost of that supplier relationship is real.
Should I calculate EOQ for every SKU?
Rarely worth it. On a catalogue of a few hundred SKUs, most lines are low volume and ordered alongside something else. Run EOQ on your top sellers and anything with a per-order fee attached, and leave the long tail to case packs and judgement.