What inventory really costs

Holding stock costs money every day, ordering costs money every time, and running out costs sales. The best quantity balances all three.

How much to order each time

Ordering costHolding costTotalEconomic order quantityYour order size

Drag the white line, or use the “Units per order” slider.

A simulated year with your order size

Same product, 14-day lead time, demand that varies day to day. The reorder point covers the lead time plus a small buffer.

Holding (interest · storage · risk)OrderingLost salesReorder point

Day 365

Carrying rate: 25%
Holding / year: $6,000
Ordering / year: $776
Total / year: $6,776
Orders / year: 9.1
Extra vs EOQ: +$2,461

Stock on a shelf looks like an asset, but it is also a bill that keeps running. Every day it sits there, it ties up cash you could use elsewhere, it takes space and people to look after it, and some of it will break, expire or go missing.

Ordering has its own bill. Each purchase order means paperwork, customs, freight and someone receiving the truck. Order in small lots and you pay that bill again and again.

And if you order too little, too late, the shelf goes empty and the customer buys from someone else. That margin is gone for good — and sometimes the customer too.

The chart above shows the trade-off. Big orders: few purchase orders, but a lot of money sitting on the shelf. Small orders: little stock, but a purchase order every few days. Somewhere in between is the cheapest point — the economic order quantity, or EOQ.

Three kinds of inventory cost

Holding (carrying) cost% of the product's cost, per year

What it costs to keep one unit on the shelf for a year. Most companies land between 20% and 35%.

Capital: the interest you pay, or could earn, on the money tied up in stock.
Storage and handling: rent, racks, forklifts, insurance, people counting and moving boxes.
Risk: parts that become obsolete, get damaged, expire or simply disappear.

Ordering cost$ per purchase order

Paid once every time you place an order, whatever the quantity.

Admin: quoting, approving and following up the PO.
Customs broker, import paperwork and port fees.
Freight for the shipment and receiving it at the warehouse.

Stockout cost$ per unit you could not sell

The price of an empty shelf. It rarely shows up in the accounts, which is why it is easy to ignore.

Lost margin on the sale that went to a competitor.
Emergency freight or a rush purchase at a worse price.
A customer who stops calling you first.

EOQ = √(2 · D · S / H)

D = 3,650 units a year · S = $85 per order · H = $30 per unit a year → EOQ ≈ 144 units

What the EOQ formula leaves out

The formula assumes steady demand and no stockouts. Real life adds safety stock (lesson 2), volume discounts, full containers and suppliers who sell you many products at once. The next lesson shows how buying several products together changes the answer. Also notice how flat the bottom of the curve is: being 20% away from the EOQ costs very little, so round to a practical pack or pallet size.

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What to remember

Holding cost is a percentage of what the stock is worth, per year: interest + storage + risk. 20–35% is common.
Ordering cost is paid per purchase order, not per unit — so bigger orders spread it thinner.
Stockouts cost margin and customers, even if they never appear in the accounts.
The EOQ is where ordering and holding cost are equal. Around it the total barely moves, so round to practical sizes.
When money gets expensive or products are valuable, order less each time. When orders get expensive, order more.