Post 2 and Post 4 answered when to order: when stock falls to the reorder point. They did not answer how much to order each time. Order too little and the business spends its days raising purchase orders and receiving small deliveries. Order too much and cash sits in the warehouse. This post sets the order quantity for two of the Ridgeline Coatings materials from Post 4, using the classic economic order quantity, and then shows why the real answer is often a truckload.
The two questions, together
A reorder-point system has two settings for each item:
- Reorder point (when). Average demand during the lead time plus safety stock. Post 4 set it at 33,324 kg for epoxy resin RM-01.
- Order quantity (how much). The amount ordered each time stock reaches the reorder point. This post sets it.
The two interact. Average stock on hand is roughly the safety stock plus half the order quantity, so a larger order raises average inventory one for one.
The economic order quantity
Each order has a fixed cost: raising and approving the purchase order, receiving, inspection and paying the invoice. Holding stock has a cost too: the capital tied up, storage, insurance and the risk of damage or obsolescence, usually expressed as a percentage of the item's cost per year. Small orders keep holding cost low but make ordering cost high; large orders do the opposite. The economic order quantity (EOQ) balances the two:
EOQ = √( 2 × D × S / H )
where D is annual demand, S the cost of placing one order and H the cost of holding one unit for a year.
Worked example: two Ridgeline materials
| Input | RM-01 Epoxy resin | RM-08 Dispersant additive |
|---|---|---|
| Average weekly use (from Post 4) | 3,462 kg | 46 kg |
| Annual demand, D | 180,024 kg | 2,392 kg |
| Unit cost | $4.20 | $14.00 |
| Cost per order, S | $250 (incl. incoming QC test) | $150 |
| Holding cost, H (25% a year) | $1.05 per kg a year | $3.50 per kg a year |
| EOQ | 9,259 kg | 453 kg |
| Weeks of use per order | 2.7 | 9.8 |
| Orders per year | 19 | 5 |
| Reorder point (from Post 4) | 33,324 kg | 599 kg |
| Average stock ≈ safety stock + EOQ/2 | 17,183 kg | 455 kg |
For epoxy resin, the EOQ is about 2.7 weeks of use per order. For the low-volume dispersant it is about 10 weeks, because the fixed cost of an order is large relative to what is bought. Before accepting that, check the dispersant's shelf life: ten weeks of an additive with a six-month shelf life is fine; with a two-month shelf life it is not.
The curve is flat at the bottom
The most useful property of the EOQ is that the total cost curve is flat near its minimum. Ordering 30% less or 40% more than the EOQ raises the combined ordering and holding cost by only a few percent. That makes the EOQ robust to rough estimates of S and H, and it means practical constraints can usually override it at little cost.
When the truckload wins
Real suppliers sell in lots, pallets, totes and truckloads, and they price accordingly. Suppose Ridgeline's resin supplier offers a 2% discount on full 20,000 kg truckloads. Compare a year of each:
| Annual cost | EOQ, 9,259 kg | Truckload, 20,000 kg |
|---|---|---|
| Ordering + holding | $9,722 | $12,540 |
| Material | $756,101 | $740,979 |
| Total | $765,823 | $753,519 |
The truckload costs more to hold, but the discount is worth more than the extra holding cost, saving about $12,303 a year. The truckload is the better choice, provided two checks pass:
- Storage. Peak stock just after a delivery is the safety stock plus the order: 12,554 + 20,000 = 32,554 kg. The tank or warehouse must hold it.
- Cash. Average stock rises from about 17,183 kg to 22,554 kg, about $22,556 more inventory on the balance sheet. A business short of working capital may still choose the smaller order.
Setting the rules in your system
- Calculate the EOQ for class A and B items. For class C items, a simple rule, such as three or six months of use, is usually good enough.
- Round to the supplier's pack size, pallet or truckload, and test any quantity discount as above.
- Check the result against shelf life, storage capacity and cash.
- Enter the reorder point from Post 2 or Post 4 and the order quantity from this post in the ERP, and review both at least yearly.
Your checklist
- Estimate the cost of placing one order, including receiving and inspection
- Set a holding cost rate, typically 20 to 30% of item cost a year
- Calculate the EOQ for class A and B items
- Test pack sizes and quantity discounts against the EOQ
- Check peak stock against storage and shelf life
Next in the series: Post 6 steps back from individual items to the monthly plan that sets how much the plant will make and buy.
Chmltech Ltd. helps small and mid-sized businesses improve operations and adopt digital tools. If you would like help applying this to your own inventory, get in touch.
