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02 Inventory Management EOQ

The document discusses inventory management and the economic order quantity (EOQ) model. It defines key inventory terms like item cost, fixed ordering cost, holding cost, lot/batch size, and demand. The EOQ model aims to minimize total annual inventory holding and ordering costs by determining the optimal lot size. It presents the EOQ formula and how to calculate EOQ given costs and demand parameters. Sensitivity analysis shows how changes in demand, costs, or holding costs impact EOQ and total costs. Practical issues with fractional or non-standard lot sizes are also noted.

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GAYATRI K SHENOY IPM 2017-22 Batch
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131 views

02 Inventory Management EOQ

The document discusses inventory management and the economic order quantity (EOQ) model. It defines key inventory terms like item cost, fixed ordering cost, holding cost, lot/batch size, and demand. The EOQ model aims to minimize total annual inventory holding and ordering costs by determining the optimal lot size. It presents the EOQ formula and how to calculate EOQ given costs and demand parameters. Sensitivity analysis shows how changes in demand, costs, or holding costs impact EOQ and total costs. Practical issues with fractional or non-standard lot sizes are also noted.

Uploaded by

GAYATRI K SHENOY IPM 2017-22 Batch
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Inventory Management

EOQ

Sanjay Choudhari

Indian Institute of Management


Indore
Objective of Inventory Control
⚫ To maximize the level of customer service by
avoiding understocking
⚫ To promote efficiency in production or
purchasing by minimizing the cost of providing
an adequate level of customer service

How much to order or produce ?


When to order or manufacture new lots ?
Terms used in Inventory
• Item cost = Ci (Average price paid per unit purchased is a key cost in the
lot-sizing decision )

• Fixed ordering cost = Co (Fixed ordering cost includes all costs that do
not vary with the size of the order but are incurred each time an order is
placed)

• Holding cost = Ch = %*Ci (Holding cost is the cost of carrying one unit in
inventory for a specified period of time i.e. $ CH/Unit/Year)

• Quantity in a lot or batch size = Q (Quantity is either produced or


purchased at a time, EOQ* = Q* )

• Demand per unit time = D (i.e. Demand in one 1 year, d = average


demand per week, So, D = d *52 / year)
Economic Order Quantity
⚫ The lot size, Q, that minimizes total annual
inventory holding and ordering costs is EOQ/Q*
Assumptions
1. The company knows the demand rate for the item and it is
constant over time.
2. The company produces the item in lots.
3. Each lot or order arrives in a single delivery.
4. The company knows the lead time (time between ordering to
receipt) and it is constant.
5. The company bases its inventory holding cost on average
inventory.
6. Ordering or setup cost are constant.
7. The company satisfies all demands for the product (no
backorder)
8. No quantity discounts is available
Concepts of Inventory as I/P in this Covid
situation
Economic Order Quantity 1
⚫ The lot size, Q, that minimizes total annual inventory holding and
ordering costs is EOQ/Q*
Economic Order Quantity 2
⚫ The lot size, Q, that minimizes total annual inventory holding and
ordering costs is EOQ/Q*
Economic Order Quantity 3
⚫ The lot size, Q, that minimizes total annual inventory holding and
ordering costs is EOQ/Q*
Calculating EOQ

Receive Inventory depletion


order (demand rate)
On-hand inventory (units)

Q Average
cycle
2 inventory

1 cycle, LT
Time
Calculating EOQ

Annual item cost = (Annual demand) * (Unit item cost) = D*Ci

Annual ordering cost = (Number of orders/Year) * (Ordering or


Setup costs) = (D/Q) * Co

Annual holding/carrying cost = (Average cycle inventory) *


(Unit holding cost) = (1/2)*Q*Ch

Total annual inventory costs


= Annual item cost +
Annual holding/carrying cost +
Annual ordering or setup cost
Calculating EOQ

Annual cost (dollars)

Total cost

Holding cost

Ordering cost

Lot Size (Q)


Calculating EOQ

Total annual inventory holding and ordering cost

Q D
TC = (CH) + (Co)
2 Q

where
TC = Total annual inventory holding and ordering cost
Q = lot size
CH = holding cost per unit per year
D = annual demand
Co = ordering or setup costs per lot
Calculating EOQ

⚫ The EOQ formula:

2 D Co
Q*=
CH
⚫ Time between orders

Q*
TBOQ* = (12 months/year)
D

⚫ Number of orders
D
n=
Q*
Managerial Insights

SENSITIVITY ANALYSIS OF THE EOQ


Parameter EOQ Parameter EOQ Comments
Change Change

Increase in lot size is in proportion to


Demand 2DCo
CH
↑ ↑ the square root of D.

Weeks of supply decreases and


Order/Setu
p Costs
2DCo
CH ↓ ↓ inventory turnover increases because
the lot size decreases.

Holding Larger lots are justified when holding


Costs
2DCo
CH
↓ ↑ costs decrease.
Managerial Insights : Few Issue
• EOQ suggests fractional value for situation which
can be procured in discrete units (Q* of 2.3 lorries
make no sense)
• Supplier are unwilling to split standard package
sizes (Q* of 227 kg cement as each bag is of 50 Kg)
• Deliveries are made by vehicles with fixed capacity
(Q* of 13 ton when each vehicle is of 12 ton
capacity)
• It is sometime make it convenient to make order
size to some suitable number
Managerial Insights : Few Issue

TC 1 Q Q*
+
TC* = 2 Q* Q

The total cost curve is flat near EOQ


– So, the total cost does not change much with a slight
change in the order quantity
Managerial Insights

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