min read
Optimal Order Quantity Formula & Calculation For Accurate Inventory
Optimal order quantity is an important inventory calculation for direct-to-consumer (DTC) retailers. For one, optimal quantity help businesses place timely orders and avoid costly stockouts events. But it can also improve revenue in a big way.
By incorporating optimal quantity into your strategy for inventory management, you can set yourself up for operational success and a more satisfied customer base.
Optimal order quantity is the most cost-effective amount of inventory that a business should have at any given time. Put simply, this calculation represents your ideal order size to meet demand without tying up too much working capital in excess stock. This calculation is also known as economic order quantity (EOQ) and is crucial for businesses to keep inventory costs low.
With the help of the optimal order quantity formula, you can minimize inventory expenses related to ordering, receiving, and storing your products.
For product-powered brands, calculating optimal order quantity is one of the most efficient methods for managing inventory, reducing dead stock, and boosting revenue.
A reorder point (ROP) indicates when your stock needs to be replenished. Meaning, it tells you when to repurchase products, so you don’t run out. And your ROP works hand in hand with optimal order quantity to ensure you always have the right amount of inventory at the right time.
In fact, the optimal order quantity formula helps you find the best reorder point for your business. So, when your inventory falls below a certain level, you know to reorder. This way, you safely avoid a stockout and fulfill orders as planned.
Dead stock refers to unsold products that take up space at your warehouse (and are unlikely to move anytime soon). And this dead inventory can be pretty costly for your business — since you have to pay more storage fees the longer those SKUs sit still.
In fact, dead stock is estimated to cost brands 30% more than what the inventory is actually worth.
The good news is, optimal quantity helps you order the right amount of inventory to prevent dead stock from accumulating in the first place. With the EOQ formula, you can decrease order inconsistencies and ensure you don’t over-purchase when demand is low.
Even before the pandemic introduced new supply chain management challenges, retailers lost out on nearly $1T in sales due to out-of-stock events. That number is staggering, but it also poses a huge opportunity to give your brand a leg up on the competition.
How? By leveraging optimal order quantity to reduce inventory shortages and stockout events. EOQ offers inventory visibility, i.e., insight into your past, present, and future stock counts to help you calculate how much (and how often) to reorder.
This way, you can ensure you always have enough inventory available to satisfy demand. And when you’re competition’s out of stock, you can swoop in and steal the sale.
Inventory costs are known by a few different names; however, carrying costs and holding costs tend to be the most popular. These costs are what retailers pay to store their inventory at one or more warehouse locations.
For most DTC sellers, inventory carrying costs account for 15-30% of their total inventory value. But by using order quantity metrics to gauge what you do and don’t need to buy, retailers can operate with a leaner inventory.
The EOQ formula finds the optimal number of units to purchase, so you’re not over-ordering products with a low velocity (or reordering goods you already have in stock). And in the process, you can minimize operational overhead, freeing up working capital and growing your margins.
Smart, streamlined inventory management is the foundation for a successful retail brand. When your inventory is well-organized and optimized for efficiency, you put your company in the best position to increase retention and drive revenue.
Optimal order quantity helps DTC merchants manage their inventory and make better business decisions across the board. By relying on EOQ, you can say goodbye to guesswork and gut feelings and instead order exactly what you need, exactly when you need it.
When retailers have too little or too much inventory on hand, it often becomes a barrier to their profitability. Excess stock translates to greater storage costs, whereas insufficient stock limits your fulfillment capacity. So whatever way you look at it, your revenue will take a hit.
Thankfully, optimal order quantity makes it easy to keep inventory levels right where you want them. And when you have the products you need (nothing more, nothing less), you can fulfill orders accurately and on time. This then gives a huge boost to your overall earnings.
Before you can calculate optimal order quantity, there are a few inventory analytics you’ll want to familiarize yourself with. Namely, annual unit demand, order costs per purchase, and holding costs per unit.
As its name suggests, annual unit demand is the customer demand you receive for a specific product each year. To confirm annual demand for your own business, take a look at your historical inventory data like turnover ratio, reorder points, and purchase orders.
These data points will give you a good idea of how many units you’ve sold year-over-year. And it will make it easier to accurately calculate EOQ.
Order costs per purchase are all the costs involved with creating and processing an order with a supplier. This might include preparing a purchase order or inspecting goods on arrival.
And these expenses have a big influence on optimal order quantity. Not only do order costs feed into total inventory costs, but they also affect certain aspects of order fulfillment (like receiving a shipment or storing goods at a warehouse).
Holding costs per unit typically happen 2 ways:
Before calculating EOQ, you’ll need to know what you spend on inventory holding costs per unit annually.
To calculate holding costs, use the following formula:
inventory holding cost = (employee salaries + storage costs + opportunity costs + depreciation costs) / total value of annual inventory
Or, in other words, start by adding employee salaries, storage fees, opportunity costs, and depreciation costs. Then, divide this sum by the total value of your annual inventory. The answer (expressed as a percentage) will be your inventory holding cost.
To calculate optimal order quantity for your DTC brand, use the following formula:
optimal order quantity = the square root of ([2DO] / H)
Note that in this equation:
Let’s look at the EOQ calculation a little closer by breaking it into 4 distinct steps:
Let’s consider how this formula might work in the real world. Imagine you’re a DTC brand that sells 1,000 lavender candles each year. Your company pays $4 per unit to hold these candles in inventory, and the order cost comes in at $2 per purchase.
In this scenario, the optimal order quantity = the square root of (2 x 1,000 candles x $2 order cost) / ($4 holding cost). When rounded, you should get an answer of 31.6.
This means the optimal amount of lavender candles is ~32 units. By ordering this quantity, you’ll adequately meet demand while simultaneously minimizing overhead costs.
However, this EOQ calculation assumes your business’ growth has plateaued. Or, if you’re still growing, you must routinely rerun your calculation for accuracy, which can be time-consuming.
Luckily, you can simplify this process by keeping a close eye on your inventory levels using an ops optimization tool like Cogsy. This tool allows you to monitor all your inventory data — real-time and historical — in a single source of truth.
With access to this data, Cogsy automatically runs optimal quantity calculations for you (and does so continuously as your brand grows or product offerings change).
Plus, Cogsy then uses your unique replenish point to autofill a PO and remind you when to restock. This way, you can ensure operational excellence (meaning you’re fully stocked up while keeping costs down) in less time and with much less effort.
There’s no doubt optimum order quantity is a very useful tool. But the accuracy of your calculations hinges on a few assumptions about product demand, storage, and more.
As you read through these 6 assumptions, keep in mind that the ‘constants’ must all happen within the same time period. If not, your end calculations are going to be way off.
For your EOQ calculations to be correct, product demand must remain constant over a designated time frame (like a fiscal quarter or a full calendar year). This way, you know that fluctuations in the demand curve aren’t affecting your order projections.
Another assumption about EOQ is that holding costs remain constant, as well. This means the fees to store your unsold inventory are unchanged over a specified period. Fixed costs are easier to plug into the EOQ formula and can be trusted to deliver accurate results.
Unit order prices must remain constant to use optimal order quantity to its full advantage. Changes to unit prices will likely throw off EOQ calculations’ accuracy and make it more difficult to understand when (and how much) to reorder.
Setup costs are all the costs related to ordering your inventory, like those for packaging and delivery. Although these costs can change over time, you’ll have to find a window where they’re consistent if you want a clear picture of your replenishment needs.
It’s safe to say nobody likes dealing with delays in the supply chain since these disruptions can negatively impact both productivity and profitability. Getting the most out of the EOQ formula will require your orders to arrive on time, every time.
The final assumption about optimal order quantity is that none of your products were sold to you at a discounted rate. That is to say, you haven’t received a bulk discount or similar incentive for purchasing large volumes of inventory all at once.
Want to reap the benefits of optimal order quantity? Cogsy can help you stay on top of your inventory levels. This way, you always have the most precise calculations possible.
Every company that partners with Cogsy has access to automatic replenish alerts. Because these notifications are happening around the clock, you’ll have visibility into your stock counts and product movement like never before.
What’s more, Cogsy’s innovative replenish alerts empower your brand to purchase inventory more proactively, so you never miss out on a single revenue opportunity.
The reality of manual spreadsheets is that they’re prone to human error and inaccuracies. This winds up costing you a lot of money since your ordering process is totally thrown off.
Fortunately, Cogsy operates in real-time, so you can eliminate all that guesswork and optimize your purchase order process. With just 1 click, Cogsy creates an optimized purchase order with the exact amount of inventory you need.
Cogsy’s operations platform is a single source of truth for all your inventory data. With Cogsy, you can store real-time and historical data in one place, so it’s readily accessible at any time.
This clarity is the key to maintaining inventory control and allows you to capitalize on the growth opportunities that cross your path. After all, you need clarity to turn insights into actions that can take your company to the next level.
But don’t take our word for it – try Cogsy free for 14 days.
Although optimal order quantity has its fair share of advantages, there are some limitations with it, as well. For instance, optimal quantity assumes your product demand, holding costs, and unit order prices remain unchanged by inventory shortages or purchase discounts.
Optimal order quantity is a calculation that determines the most cost-effective amount of inventory for your company to purchase. Essentially, this calculation represents your ideal order size to meet demand without overspending on excess stock. Minimum order quantity (MOQ), on the other hand, is the amount of product a supplier requires that you buy at one time.
Safety stock describes the extra product you keep on hand to prevent an out-of-stock situation. The optimal safety stock quantity for your retail brand depends on your:
![Inventory Risk: What Is It And How To Handle It [+ Examples]](https://cogsy.com/wp-content/uploads/2023/02/Inventory-risk-post.jpg)