In one sentenceThe order size that keeps the total of ordering costs and inventory holding costs at the lowest possible level over the year.
Simply put
Every order has a cost (shipping, paperwork and time), and every unit in the warehouse has a holding cost (space, insurance and tied-up money). Large orders reduce the first and increase the second.
The economic order quantity is the balance point between them. It is a useful theoretical estimate, which you adjust in practice for quantity discounts and the supplier's carton size.
Worked example
A store sells 3,600 units of an item per year, the cost of placing one order is 50 SAR, and the cost of holding one unit is 4 SAR per year.
2 × annual demand × cost per order2 × 3,600 × 50 = 360,000
÷ Holding cost per unit360,000 ÷ 4 = 90,000
Number of orders per year3,600 ÷ 300 = 12 orders
Economic order quantity = √90,000300 units
Formula: Square root of (2 × annual demand × cost per order ÷ annual holding cost per unit)
Don't confuse it with
Reorder pointThe reorder point decides the timing of the order, and the economic quantity decides its size.