EOQ Calculation
Determination of the proper amount to order is an important step in optimizing inventory investment.  Procuring a small quantity every month may minimize storage costs and keep the stock low.  However, this may result in higher administrative costs to place these orders and handle the stock each month.  Conversely, ordering once a year may mean minimal  administrative costs.  However, this approach would certainly mean high carrying costs and storage costs to keep extra stock on the shelf when it is not needed.

The Economic Order Quantity (EOQ) is a value derived from projected forecasts.  After a forecast is determined for an item, SMS compares various options.  Sms further compares the cost of carrying and storage vs. the cost of administration and handling for each option.  SMS finds the EOQ quantity which minimizes this combined cost.  SMS determines the right size to procure - not too much, not too often, not too little.  This combined cost is known as the "Total Annual Cost".  The carrying cost is known as the "Cycle Stock" cost.  The administrative cost of handling orders is known as the "Receiving Cost".  In some cases, safety stock cost and purchase F.O.B. terms may have a small impact.  The sum of all these costs should be the lowest point.

This is shown below and in the subsequent discussion of calculation approach. The lowest point of the RED line indicates the proper Replenishment Quantity to buy.

eoq_components