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What is Optimal Order Quantity?
By Nick Spooner
CEO at Salesorder.com | Software and expertise for wholesaler optimization
It’s one of the many things that our wholesale inventory management software can help with and something that should be considered by all companies that hold inventory. In the following guide, we’ll take a closer look at optimal order quantity, addressing questions such as:
- What is an optimal order quantity formula?
- How do I use an optimal ordering quantity calculator?
- Is optimal order quantity the same as EOQ?
- Are there any limitations of calculating optimal quantity?
Why should you calculate your optimal order quantity?
Calculating optimal order quantity is one of the most efficient ways for brands to manage inventory. Also known as economic order quantity (EOQ), one of the main goals is to avoid tying up too much working capital on excess stock.
It also provides the following benefits:
Reduce storage costs
The less stock you have, the lower your storage costs will be. It’s a simple equation, but it’s one that could save thousands in storage costs without adversely affecting sales.
After all, the point of optimal order quantity is to purchase the ideal stock quantity, an amount that’s enough to cover orders without leaving too much excess stock. So, your customers will be happy and your orders will be satisfied but you won’t be left with piles of perishable stock taking up space and costing money.
Figure out the best reorder point
ROP works in perfect synergy with optimal order quantity to warn you when more products are needed and provide insights into how much stock should be ordered.
Won't run out of stock
By providing more inventory visibility, optimal order quantity can help to prevent product shortages without forcing retailers to buy more product that they are comfortable and can realistically hold.
Efficient inventory management
Proper inventory management begins with a simple but efficient optimal order quantity formula. Stock will always be ready to sell and ship and you don’t have to worry about accumulating dead stock, which refers to products that take up inventory space and gradually shift toward best-before/use-by dates.
What’s more, when your inventory is streamlined, you’ll seen an improvement in customer retention and customer satisfaction, helping your business to grow.
If you take dead stock out of the equation, reduce storage costs, keep popular items in stock, and eliminate the need to constantly tell customers that their order will be late, you should see a marked increase in company revenue.
What you need to know before calculating your optimal order quantity?
Before we show you how to calculate optimal order quantity, there are a couple of things that you need to know:
Calculate annual usage
The annual usage is the total product demand over the course of a year.
Consider your turnover ratio, purchase orders, and reorder points to get an idea of how many units you see during any specific year.
Calculate setup usage
The setup usage is the total cost of creating and processing orders, including everything from the initial purchase order to the final inspection when the goods arrive.
Calculate annual holding cost per unit
Holding costs are calculated in one of two ways. The simplest method is to focus purely on storage costs, but that doesn’t paint a complete picture.
The preferred solution is to use the following calculation: inventory holding cost = (staff salaries + storage costs + opportunity costs + depreciation costs) / total value of annual inventory.
Let’s look at each of those things in more detail:
- Staff salaries: The annual cost of hiring each employee
- Storage costs: The fees charged for storing inventory, such as warehousing costs.
- Opportunity costs: A “lost” opportunity cost, such as when you hold dead stock instead of more profitable stock.
- Deprecation costs: The money lost via product depreciation, either a sa result of steadily perishing items or products that become obsolete.
The answer to this equation (when expressed as a percentage) is your inventory holding cost.
The optimal order quantity formula
optimal order quantity = square root of ([2DS] / H)
- D is the annual demand
- S is the setup cost per purchase
- H is the holding cost
To break it down a little more:
- Multiply D by S
- Multiple by 2
- Divide by H
- Calculate the square root
You pay $5 to hold them in inventory and $3 per purchase.
So, the optimal order quantity would begin with the following calculation:
(2 x 5,000 bottles x $3 setup cost) / $5 holding cost
The answer to the above is 6,000, the square root of which is 77.4. If we round up, we get 78, which is how many bottles should be ordered to avoid dead stock, excess storage fees, and other such issues.
Streamline your wholesaler business with Salesorder
Finding your optimal order quantity can reduce cost, loss, and dead stock while increasing revenue. It makes a massive difference to product-focused businesses at all levels.
To discover how you can benefit from better inventory management, including automated ordering, product tracking, and credit control automation, check out our faster wholesale order management.
We also have solutions for wholesale warehouse management. Click the links to discover how Salesorder can help you.
Yes, optimal order quantity is also known as EOQ, which stands for economic order quantity.
No. The former is the ideal amount, as discussed in the above guide, while MOQ stands for minimum order quantity and references the lowest number of units that must be purchased. The MOQ number is set by wholesalers.
Yes, there are a few. The biggest is that it assumes demand will be constant and doesn’t account for discounts. However, good inventory management software can help with other aspects and provide a complete solution.