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    Economic Order Quantity (EOQ) : Cost Management - MFM - Semester I

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    Economic order quantity (EOQ) is the order amount that minimizes total inventory costs, including ordering costs and holding costs. The EOQ model assumes constant demand, no stockouts, instant replenishment, and other simplifying conditions. To calculate EOQ, the annual demand, ordering cost, holding cost percentage, and unit purchase price are used in the EOQ formula. EOQ is independent of purchase price and depends only on demand, ordering cost, and holding cost. An example calculation shows that using the EOQ of 500 units results in the lowest total inventory costs compared to other order amounts.

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    Economic Order Quantity (EOQ) : Cost Management - MFM - Semester I

    Uploaded by

    mongar
    1K views24 pages
    Economic order quantity (EOQ) is the order amount that minimizes total inventory costs, including ordering costs and holding costs. The EOQ model assumes constant demand, no stockouts, instant replenishment, and other simplifying conditions. To calculate EOQ, the annual demand, ordering cost, holding cost percentage, and unit purchase price are used in the EOQ formula. EOQ is independent of purchase price and depends only on demand, ordering cost, and holding cost. An example calculation shows that using the EOQ of 500 units results in the lowest total inventory costs compared to other order amounts.

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    Economic Order Quantity

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    Economic order quantity (EOQ) is the order amount that minimizes total inventory costs, including ordering costs and holding costs. The EOQ model assumes constant demand, no stockouts, instant replenishment, and other simplifying conditions. To calculate EOQ, the annual demand, ordering cost, holding cost percentage, and unit purchase price are used in the EOQ formula. EOQ is independent of purchase price and depends only on demand, ordering cost, and holding cost. An example calculation shows that using the EOQ of 500 units results in the lowest total inventory costs compared to other order amounts.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    1K views24 pages

    Economic Order Quantity (EOQ) : Cost Management - MFM - Semester I

    Uploaded by

    mongar
    Economic order quantity (EOQ) is the order amount that minimizes total inventory costs, including ordering costs and holding costs. The EOQ model assumes constant demand, no stockouts, instant replenishment, and other simplifying conditions. To calculate EOQ, the annual demand, ordering cost, holding cost percentage, and unit purchase price are used in the EOQ formula. EOQ is independent of purchase price and depends only on demand, ordering cost, and holding cost. An example calculation shows that using the EOQ of 500 units results in the lowest total inventory costs compared to other order amounts.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 24

    Economic Order Quantity (EOQ)

    Cost Management MFM Semester I


    Contributing Members: Rahul Monga (Roll No: 18)

    Definition
    Economic order quantity is the level of inventory that minimizes total inventory holding costs and ordering costs. It is one of the oldest classical production scheduling models.

    The framework used to determine this order quantity is also known as Wilson EOQ Model or Wilson Formula. The model was developed by Ford W. Harris in 1913, but R. H. Wilson, a consultant who applied it extensively, is given credit for his in-depth analysis.

    EOQ applies only when demand for a product is constant over the year and each new order is delivered in full when inventory reaches zero. There is a fixed cost for each order placed, regardless of the number of units ordered. There is also a cost for each unit held in storage, sometimes expressed as a percentage of the purchase cost of the item.

    EOQ Model Cost Curves


    Minimum Total Cost Annual cost Total Cost

    Holding Cost = H*Q/2

    Ordering Cost = O*D/Q Optimal Order Quantity Order Quantity, Q

    The required parameters to the solution are 1. the total demand for the year, 2. the purchase cost for each item, 3. the fixed cost to place the order and 4. the storage cost for each item per year.

    Underlying assumptions

    The ordering cost is constant. The rate of demand is known, and spread evenly throughout the year. The *lead time is fixed. The purchase price of the item is constant i.e. no discount is available The replenishment is made instantaneously, the whole batch is delivered at once. Only one product is involved.

    *Lead Time: lead time is the latency (delay) between the initiation and execution of a process.

    Variables
    Q = order quantity Q * = optimal order quantity D = annual demand quantity of the product P = purchase cost per unit S = fixed cost per order (not per unit, typically cost of ordering and shipping and handling. This is not the cost of goods) H = annual holding cost per unit (also known as carrying cost or storage cost) (warehouse space, refrigeration, insurance, etc. usually not related to the unit cost)

    EOQ Formula
    The single-item EOQ formula finds the minimum point of the following cost function: Total Cost = Purchase Cost + Ordering Cost + Holding Cost

    Purchase cost: This is the variable cost of goods: purchase unit price annual demand quantity. This is PD

    Ordering cost: This is the cost of placing orders: each order has a fixed cost S, and we need to order D/Q times per year. This is S D/Q

    Holding cost: The average quantity in stock (between fully replenished and empty) is Q/2, so this cost is H Q/2

    Total Cost = purchase cost + ordering cost + holding cost

    To determine the minimum point of the total cost curve, set the ordering cost equal to the holding cost:

    Solving for Q gives Q* (the optimal order quantity):

    Therefore: Q* is independent of P; it is a function of only S, D, H.

    Example

    Suppose annual requirement quantity (Q) = 10000 units Cost per order (CO) = $2 Cost per unit (CU)= $8 Carrying cost %age (%age of CU) = 0.02 Carrying cost Per unit = $0.16

    Economic order quantity =

    EOQ = 500 units

    Number of order per year (based on EOQ)

    Number of order per year (based on EOQ) = 20

    Total Cost = Purchase Cost + Ordering Cost + Holding Cost Total Cost (TC) = CU * Q + CO(Q / EOQ) + CC(EOQ / 2) TC = 8 * 10000 + 2(10000 / 500) + 0.16(500 / 2)

    Total Cost (TC) = $80080

    If we check the total cost for any order quantity other than 500 (=EOQ), we will see that the cost is higher. For instance, supposing 600 units per order, then Total cost = 8 * 10000 + 2(10000 / 600) + 0.16(600 / 2) Total cost = $80081

    Similarly, if we choose 300 for the order quantity then Total cost = 8 * 10000 + 2(10000 / 300) + 0.16(300 / 2) Total cost = $80091

    This illustrates that the Economic Order Quantity is always in the best interests of the entity.

    Thank You

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