What is the EOQ reorder point?

The EOQ reorder point is a contraction of the term economic order quantity reorder point. It is a formula used to derive that number of units of inventory to order that represents the lowest possible total cost to the ordering entity.

It essentially creates a least-cost balance between the cost of ordering inventory and the cost of holding inventory.

The EOQ reorder point is derived from this formula:

The inputs to the model are noted within the formula.

For example, ABC International uses 100,000 pounds of aluminum ingots per year, and the cost to place each order is $15. The carrying cost for one pound of aluminum ingots is $5 per year. The EOQ reorder point, based on this information, is the square root of:

(2 x 100,000 x $15) / $5

= EOQ reorder point of 775 units

It is useful to test variations on the ordering cost and annual carrying cost to see how they impact the EOQ. It is possible that driving down the annual carrying cost of inventory can significantly alter the EOQ reorder point. A key factor in this analysis is determining which carrying costs actually vary with inventory volumes, and which are unrelated fixed costs. If they are unrelated, do not include them in the denominator of this calculation.

The EOQ reordering system is not used in "pull" manufacturing systems, where components are ordered from suppliers only as needed and in the quantities needed; thus, a pull system tends to order fewer components than an EOQ reordering formula would indicate as optimal.

Related Topics

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