Economic order quantity explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
Order too often and you pay for paperwork, transport and inspection each time. Order too much and cash sits in the godown, along with the cost of space, insurance and spoilage. Economic order quantity, together with reorder, minimum and maximum levels, tells a purchase manager how much to order and when to place the order.
The economic order quantity is the order size at which the yearly cost of placing orders equals the yearly cost of carrying stock, and the total of the two is lowest. In symbols, EOQ = square root of (2 × annual usage × cost per order ÷ carrying cost per unit per year). Stock levels (reorder, minimum, maximum) then turn the quantity into a timetable. Use them to fix a standing order size and a reorder trigger for each important material.
What the technique answers and the data you need
For each raw material you want two answers: how many units per order, and at what stock balance to place the order. Setting these controls up across a range of materials is the core of an inventory management setup. You need annual usage from the stock register, the cost of placing one order (purchase staff time, transport, inspection, payment processing), the cost of carrying one unit for a year (interest on the money tied up, storage, insurance, loss), and the delivery time you actually experience from suppliers. Purchase price is not in the EOQ formula unless the supplier changes it with order size; if it does, compare total costs including price.
The method
Step 1: the two costs. Ordering cost per year = number of orders × cost per order = (D ÷ Q) × S. Carrying cost per year = average stock × carrying cost per unit = (Q ÷ 2) × C. Here D is annual usage, Q the order quantity, S the cost per order and C the carrying cost per unit per year.
Step 2: EOQ. EOQ = √(2DS ÷ C).
Step 3: stock levels. These are in units of the material.
| Level | Formula in words | Purpose |
|---|---|---|
| Reorder level | Maximum usage × maximum lead time | Balance at which to place the order |
| Minimum level | Reorder level − (normal usage × normal lead time) | Cushion that should not be touched; acts as safety stock |
| Maximum level | Reorder level + reorder quantity − (minimum usage × minimum lead time) | Ceiling above which stock is excess |
| Average level | (Minimum + maximum) ÷ 2 | Typical stock held |
Safety stock is the cushion held against faster usage or late delivery. In this method the minimum level is that cushion; some firms instead set safety stock directly as extra days of usage. Stock-out cost (lost sales, idle labour, rush purchases) is what the cushion is protecting against.
Worked example: a packaging unit
A unit makes cartons from kraft paper. All figures are assumed.
- Annual usage D = 48,000 kg; the unit works 300 days a year, so normal usage is 160 kg a day (48,000 ÷ 300).
- Cost per order S = ₹1,500.
- Carrying cost C = ₹4 per kg per year.
- Delivery takes 4 to 8 days, normally 6. Daily usage varies between 120 and 200 kg.
EOQ = √(2 × 48,000 × 1,500 ÷ 4) = √(144,000,000 ÷ 4) = √36,000,000 = 6,000 kg.
Orders per year = 48,000 ÷ 6,000 = 8.
Cost check at three order sizes
| Order size (kg) | Orders a year | Ordering cost (₹) | Average stock (kg) | Carrying cost (₹) | Total (₹) |
|---|---|---|---|---|---|
| 3,000 | 16 | 24,000 | 1,500 | 6,000 | 30,000 |
| 6,000 (EOQ) | 8 | 12,000 | 3,000 | 12,000 | 24,000 |
| 12,000 | 4 | 6,000 | 6,000 | 24,000 | 30,000 |
At the EOQ the two costs are equal (12,000 each) and the total is lowest at ₹24,000. Ordering half or double the quantity adds ₹6,000 a year.
Stock levels
- Reorder level = 200 × 8 = 1,600 kg.
- Minimum level = 1,600 − (160 × 6) = 1,600 − 960 = 640 kg.
- Maximum level = 1,600 + 6,000 − (120 × 4) = 7,600 − 480 = 7,120 kg.
- Average level = (640 + 7,120) ÷ 2 = 3,880 kg.
What the owner decides. Place an order of 6,000 kg whenever the balance of paper, counting orders already due, falls to 1,600 kg. Treat 640 kg as the line that should never be crossed; if the balance touches it, the reorder level or the supplier's reliability needs review. If the balance rises above 7,120 kg, something went wrong in ordering.
How to read the result
The EOQ curve is flat near the lowest point. Rounding the order to 6,000 kg or to the supplier's lorry load costs little; a wildly different quantity costs real money. The levels are only as good as the usage and delivery data behind them; revisit them when sales or suppliers change. For help in choosing which materials deserve this effort, see the ABC analysis guide. Valuation of the stock you hold (FIFO or weighted average) is covered in our guide to AS 2 inventories.
Common mistakes
- Using purchase price as carrying cost. Carrying cost is the cost of holding one unit, not what it cost to buy.
- Forgetting interest. The cash tied up in stock has a cost even when no one writes a cheque for it.
- Treating lead time as a promise. Use the delivery times you have seen, not the quoted ones.
- Applying EOQ to everything. Perishables, items with quantity discounts and items bought on contract need a different approach.
- Ignoring the limits. The formula assumes steady usage and a fixed cost per order. Seasonal businesses should adjust it for the season.
Better stock control also lowers the working capital you need; the working capital cycle guide shows how.
Need help with fixing your stock levels?
If your purchasing runs on habit, a short exercise can set an order size and a reorder trigger for your ten most important materials. Our team can help with an inventory management setup built on your own usage, cost and supplier data.
Key takeaways
- EOQ = √(2DS ÷ C); at that order size, ordering cost equals carrying cost and the total is lowest.
- Reorder level = maximum usage × maximum lead time; minimum and maximum levels follow from it.
- The minimum level works as safety stock; stock-out cost is what it insures against.
- The total-cost curve is flat near EOQ, so practical rounding is fine.
- Review usage and lead-time data every year; stale data defeats the formula.
Read next
- ABC analysis, FSN and VED classification of inventory
- Batch costing and economic batch quantity
- Working capital cycle and estimating working capital requirement
Disclaimer: The methods described are standard cost accounting and financial management techniques. The worked example uses an invented business and invented figures, including any tax, interest or exchange rate, which are assumptions for illustration and not current rates. Where the article refers to a legal requirement, the linked guide and the official text should be checked. This article is general information, not legal advice; check the official text before acting.