March 25, 2024

EOQ stands for Economic Order Quantity. It is a measurement used in the field of Operations, Logistics, and Supply Management. In essence, EOQ is a tool used to determine the volume and frequency of orders required to satisfy a given level of demand while minimizing the cost per order. What Is Economic Order Quantity? Economic order quantity (EOQ) is the ideal quantity of units a company should purchase to meet demand while minimizing inventory costs such as holding costs, shortage costs, and order costs. This production-scheduling model was developed in 1913 by Ford W. Harris and has been refined over time.1 The economic order quantity formula assumes that demand, ordering, and holding costs all remain constant. Formula for Calculating Economic Order Quantity (EOQ) The Economic Order Quantity formula is calculated by minimizing the total cost per order by setting the first-order derivative to zero. The components of the formula that make up the total cost per order are the cost of holding inventory and the cost of ordering that inventory. The key notations in understanding the EOQ formula are as follows: Components of the EOQ Formula: D: Annual Quantity Demanded Q: Volume per Order S: Ordering Cost (Fixed Cost) C: Unit Cost (Variable Cost) H: Holding Cost (Variable Cost) i: Carrying Cost (Interest Rate) Ordering Cost The number of orders that occur annually can be found by dividing the annual demand by the volume per order. The formula can be expressed as: For each order with a fixed cost that is independent of the number of units, S, the annual ordering cost is found by multiplying the number of orders by this fixed cost. It is expressed as: Holding Cost Holding inventory often comes with its own costs. This cost can be in the form of direct costs incurred by financing the storage of said inventory or the opportunity cost of holding inventory instead of investing the money elsewhere. As such, the holding cost per unit is often expressed as the cost per unit multiplied by the interest rate, expressed as follows: H = iC With the assumption that demand is constant, the quantity of stock can be seen to be depleting at a constant rate over time. When inventory reaches zero, an order is placed and replenishes inventory as shown: As such, the holding cost of the inventory is calculated by finding the sum product of the inventory at any instant and the holding cost per unit. It is expressed as follows: Total Cost and the Economic Order Quantity Summing the two costs together gives the annual total cost of orders. To find the optimal quantity that minimizes this cost, the annual total cost is differentiated with respect to Q. It is shown as follows: The Importance of EOQ The Economic Order Quantity is a set point designed to help companies minimize the cost of ordering and holding inventory. The cost of ordering inventory falls with the increase in ordering volume due to purchasing on economies of scale. However, as the size of inventory grows, the cost of holding the inventory rises. EOQ is the exact point that minimizes both of these inversely related costs. What the Economic Order Quantity Can Tell You The goal of the EOQ formula is to identify the optimal number of product units to order. If achieved, a company can minimize its costs for buying, delivering, and storing units. The EOQ formula can be modified to determine different production levels or order intervals, and corporations with large supply chains and high variable costs use an algorithm in their computer software to determine EOQ. EOQ is an important cash flow tool. The formula can help a company control the amount of cash tied up in the inventory balance. For many companies, inventory is its largest asset other than its human resources, and these businesses must carry sufficient inventory to meet the needs of customers. If EOQ can help minimize the level of inventory, the cash savings can be used for some other business purpose or investment.The EOQ formula determines the inventory reorder point of a company. When inventory falls to a certain level, the EOQ formula, if applied to business processes, triggers the need to place an order for more units. By determining a reorder point, the business avoids running out of inventory and can continue to fill customer orders. If the company runs out of inventory, there is a shortage cost, which is the revenue lost because the company has insufficient inventory to fill an order. An inventory shortage may also mean the company loses the customer or the client will order less in the future. Limitations of EOQ The EOQ formula assumes that consumer demand is constant. The calculation also assumes that both ordering and holding costs remain constant. This fact makes it difficult or impossible for the formula to account for business events such as changing consumer demand, seasonal changes in inventory costs, lost sales revenue due to inventory shortages, or purchase discounts a company might realize for buying inventory in larger quantities. FAQs How Is Economic Order Quantity Calculated? Economic order quantity is an inventory management technique that helps make efficient inventory management decisions. It refers to the optimal amount of inventory a company should purchase in order to meet its demand while minimizing its holding and storage costs. One of the important limitations of the economic order quantity is that it assumes the demand for the company’s products is constant over time. How Does Economic Order Quantity Work? Economic order quantity will be higher if the company’s setup costs or product demand increases. On the other hand, it will be lower if the company’s holding costs increase. Why Is Economic Order Quantity Important? Economic order quantity is important because it helps companies manage their inventory efficiently. Without inventory management techniques such as these, companies will tend to hold too much inventory during periods of low demand while also holding too little inventory during periods of high demand. Either problem creates missed opportunities. Practice area’s of B K Goyal & Co LLP Income Tax Return Filing | Income Tax Appeal | Income Tax Notice |

A cash flow statement tracks the inflow and outflow of cash, providing insights into a company’s financial health and operational efficiency. The CFS measures how well a company manages its cash position, meaning how well the company generates cash to pay its debt obligations and fund its operating expenses. As one of the three main financial statements, the CFS complements the balance sheet and the income statement. In this article, we’ll show you how the CFS is structured and how you can use it when analyzing a company. What Is Cash Flow? Cash flow is the net cash and cash equivalents transferred in and out of a company. Cash received represents inflows, while money spent represents outflows. A company creates value for shareholders through its ability to generate positive cash flows and maximize long-term free cash flow (FCF). FCF is the cash from normal business operations after subtracting any money spent on capital expenditures (CapEx). Cash Flow Statement The cash flow statement acts as a corporate checkbook to reconcile a company’s balance sheet and income statement.1 The cash flow statement includes the “bottom line,” recorded as the net increase/decrease in cash and cash equivalents (CCE). The bottom line reports the overall change in the company’s cash and its equivalents over the last period. The difference between the current CCE and that of the previous year or the previous quarter should have the same number as the number at the bottom of the statement of cash flows.1 Below is Walmart’s cash flow statement for the fiscal year ending on Jan. 31, 2019. All amounts are in millions of U.S. dollars.2Investments in property, plant, and equipment (PP&E) and acquisitions of other businesses are accounted for in the cash flow from the investing activities section. Proceeds from issuing long-term debt, debt repayments, and dividends paid out are accounted for in the cash flow from the financing activities section. Walmart’s cash flow was positive, showing an increase of $742 million, which indicates that it has retained cash in the business and added to its reserves to handle short-term liabilities and fluctuations in the future. How the Cash Flow Statement Is Used The cash flow statement paints a picture as to how a company’s operations are running, where its money comes from, and how money is being spent. Also known as the statement of cash flows, the CFS helps its creditors determine how much cash is available (referred to as liquidity) for the company to fund its operating expenses and pay down its debts. The CFS is equally important to investors because it tells them whether a company is on solid financial ground. As such, they can use the statement to make better, more informed decisions about their investments. Types of Cash Flow Cash Flows From Operations (CFO)- Cash flow from operations (CFO), or operating cash flow, describes money flows involved directly with the production and sale of goods from ordinary operations. CFO indicates whether or not a company has enough funds coming in to pay its bills or operating expenses. Operating cash flow is calculated by taking cash received from sales and subtracting operating expenses that were paid in cash for the period. Operating cash flow is recorded on a company’s cash flow statement, indicates whether a company can generate enough cash flow to maintain and expand operations, and shows when a company may need external financing for capital expansion.3   Cash Flows From Investing (CFI)- Cash flow from investing (CFI) or investing cash flow reports how much cash has been generated or spent from various investment-related activities in a specific period. Investing activities include purchases of speculative assets, investments in securities, or sales of securities or assets.Negative cash flow  from investing activities might be due to significant amounts of cash being invested in the company, such as research and development (R&D), and is not always a warning sign.1 Cash Flows From Financing (CFF)- Cash flows from financing (CFF), or financing cash flow, shows the net flows of cash used to fund the company and its capital. Financing activities include transactions involving issuing debt, equity, and paying dividends. Cash flow from financing activities provides investors insight into a company’s financial strength and how well its capital structure is managed How to Analyze Cash Flows Free Cash Flow: FCF is a measure of financial performance and shows what money the company has left over to expand the business or return to shareholders after paying dividends, buying back stock, or paying off debt.3 Unlevered Free Cash Flow: UFCF measures the gross FCF generated by a firm that excludes interest payments, and shows how much cash is available to the firm before financial obligations.3 Operating Cash Flow: OCF is money generated by a company’s primary business operation. Cash Flow to Net Income Ratio: The ratio of a firm’s net cash flow and net income with an optimum goal of 1:1. Current Liability Coverage Ratio: This ratio determines the company’s ability to pay off its current liabilities with the cash flow from operations. Price to Money Flow Ratio: The operating money flow per share is divided by the stock price. FAQs What Is the Difference Between Cash Flow and Profit? Cash flow isn’t the same as profit. Profit is specifically used to measure a company’s financial success or how much money it makes overall. This is the amount of money that is left after a company pays off all its obligations. Profit is found by subtracting a company’s expenses from its revenues. What Is Free Cash Flow and Why Is It Important? Free cash flow is left over after a company pays for its operating expenses and CapEx. It is the remaining money after items like payroll, rent, and taxes. Companies are free to use FCF as they please. Do Companies Need to Report a Cash Flow Statement? The cash flow statement complements the balance sheet and income statement and is part of a public company’s financial reporting requirements since 1987 Practice area’s of B K Goyal & Co LLP Income Tax Return Filing | Income Tax Appeal | Income Tax Notice | GST Registration | GST Return Filing | FSSAI Registration | Company Registration | Company Audit | Company Annual Compliance | Income Tax Audit | Nidhi Company Registration| LLP Registration | Accounting in