Economic Order

Quantity
Materials Management
By - Puneet Rane
Inventory
!recursor
nventory
Role of Material Manager
Need For nventory Control
Economic Order Quantity
%e model was developed by F. W. Harris in
1915
R. H. Wilson is credited in-dept analysis of
te model
t gives optimal quantity to order tat
minimizes total variable costs required to
order and old inventory.
%e Definition of EOQ
" or Economic Order Quantity is
defined as te optimal quantity of orders tat
minimizes total variable costs required to
order and old inventory.
ow to use EOQ in your organization
ow much inventory
should we order each
month?
The EOQ tool can be used to model the
amount of inventory that we should order
each month.
%e BaIance
Maximum Stock Level
conomic Stock Level
Minimum Stock Level
ocaI !oints
Running of Plant
Capital
Carrying Cost
rdering Cost
ow EOQ Works

The Principles Behind EOQ. The Total Cost Curve

Cost Components
nnuaI Usage/Demand
Order Cost
Carrying cost
nterest
nsurance
%axes
Storage Costs & Maintenance Cost
ow EOQ Works
The Principles Behind EOQ. The Holding Costs
Keeping inventory on hand
Interest
Insurance
Taxes
TheIt
Obsolescence
Storage Costs
ow EOQ Works
The Principles Behind EOQ. The Holding Costs
Interest
Obsolescence
Storage
ow EOQ Works
The Principles Behind EOQ. The Procurement Costs
!rimarily the labor costs associated
with processing the order
Ordering and requisition
A portion oI the Ireight iI the amounts
vary according to the size oI the order
Receiving, inspecting, stocking
Invoice processing
ow EOQ Works
The Total Cost Formula
Total Cost !urchase Cost + Order Cost + olding Cost
ow EOQ Works
The Total Cost Formula
This represents the
unchanging Iixed costs
P Purchase cost per unit
R Forecasted monthly usage
ow EOQ Works
The Total Cost Formula
This represents the
variable order costs
P Purchase cost per unit
R Forecasted monthly usage
C Cost per order event 349 per unit)
Q The number oI units ordered
ow EOQ Works
The Total Cost Formula
This represents the
variable holding costs
P Purchase cost per unit
R Forecasted monthly usage
C Cost per order event 349 per unit)
Q The number oI units ordered
F Holding cost Iactor
ow EOQ Works
The EOQ Formula
Total Cost
Formula
%aking te derivative of bot sides of te equation and setting equal to
zero to find te minimum value of te function one obtains:
%e result of differentiation
ow EOQ Works
The EOQ Formula
The Economic Order Quantity
ow EOQ Works
The EOQ Formula
Review and Summary oI the EOQ Formula
P Purchase cost per unit
R Forecasted monthly usage
C Cost per order event 349 per unit)
F Holding cost Iactor
ow EOQ Works
The EOQ Formula
Review and Summary oI the EOQ Formula
Here is the a graphic representation oI the EOQ equation
Simple to calculate
%otaI cost per period = inventory oIding costs
per period + order costs per period
Cost %e Number of rders Placed in te period x
rder Costs
Carrying Cost Average nventory Level x te
Carrying Costs of 1 unit of Stock for one period
$impIifying CaIcuIations
" order quantity
A demand per time
period (e.g. Annual
Demand)
S Carrying / Holding
Cost of 1 unit of Stock
for one period
P rder Cost
dvantages
%e purpose of te " model is to minimize
te total costs of inventory.
Sortages or Stock-outs do not occur as
delivery of te order is immediate.
Assumptions of te Model
Demand is known
%e lead time
%e receipt of inventory is instantaneous
"uantity discounts are not possible
Economic Order Quantity
Production EOQ:
nstead of instantaneous replenisment we
include te finite Production Rate R wic
leads to te following formula: (You can see
tat production rate must be greater tan
demand rate in order to fulfill te demand!)
" sqrt ( 2 * A * P / (S*(1-A/R))
'ariations
"uantity discount
Spoilage or to Prevent obsolescence
Ratio of production to consumption
Safety stock calculation
Case
$top n $Iurp Convenience $tore
Annual Demand: 5200 Cases of Coca Cola
Fixed rdering Cost: 500 per order
Cost Per Case: 100
Holding Cost: 20% of value of inventory per year
Suppose " assumptions old (Constant demand no lag/lead time no sortages)
ow Muc Coca CoIa souId $top n $Iurp Order?
$oIution
" Parameters:
Annual Usage 5200
rder Cost 500
Annual Carrying Cost 20% of 100 20
ptimum rdering Policy:
" sqrt(2 x 5200 x 500)/(20) 509.9 ~ 510 Cases
CIosing Comments
" is a tool not a simple solution.
" is useful in determining optimal order
quantity
Understand te equation and wat you are
trying to find
Find accurate inputs for te equation
dditionaI Resources on EOQ
Materials Management an ntegrated Approac P.
Gopalakrisnan
Cost Accounting
ttp://www.caam.rice.edu/~timredl/caam376/
ttp://www.findarticles.com/p/articles/mi_m0KAA/is_5_31/
ai_94771293
ttp://www.inventoryops.com/economic_order_quantity.tm
ttp://www.pafis.s.fi/~stecon02/afis/ws2/
ttp://en.wikipedia.org/wiki/conomic_order_quantity