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EOQ

The document explains the concept of Economic Order Quantity (EOQ), which is the optimal order quantity that minimizes total inventory costs, including ordering and carrying costs. It outlines the assumptions underlying EOQ, different inventory models, and the basis for setting reorder points. Additionally, it provides a sample numerical calculation for EOQ and total inventory costs based on specific demand and cost parameters.

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29 views

EOQ

The document explains the concept of Economic Order Quantity (EOQ), which is the optimal order quantity that minimizes total inventory costs, including ordering and carrying costs. It outlines the assumptions underlying EOQ, different inventory models, and the basis for setting reorder points. Additionally, it provides a sample numerical calculation for EOQ and total inventory costs based on specific demand and cost parameters.

Uploaded by

adams892290
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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ECONOMIC ORDER QUANTITY (EOQ)

What is Economic Order Quantity (EOQ)?


⚫ Total Inventory cost = Inventory carrying cost +

⚫
ordering cost
Inventory carrying cost & ordering cost behave in

⚫
diametrically opposite manner
If no. of orders per year is less, then ordering /
procurement cost comes down, where as inventory

⚫
carrying cost goes up
If we try to avoid higher inventory carrying cost and
place orders frequently in small lots, then the ordering
costs go high
Economic Order Quantity(EOQ)

----Total cost(Lowest)
Cost
(Rs.)Holding cost
Ordering
cost

NO of Orders
It is that quantity where the total of ordering
cost and holding cost remains lowest
Economic Order Quantity (EOQ)
⚫ EOQ =
2 x Annual Consumption (units)X Ordering cost (per order)
Carrying (holding)cost per unit

Carrying (holding) cost per unit = Cost per unit X Carrying cost(%)
Underlying assumptions for EOQ
⚫
⚫
The ordering cost is constant.

⚫
The rate of demand is constant

⚫
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
Inventory carrying charges vary directly & linearly with

⚫
the size of inventory

⚫
Item can be procured in desired quantities : no restriction
Item has long shelf life ( no deterioration or spoilage)
Purchase inventory models
⚫
⚫
Fixed order quantity system ( Q system)
Fixed period quantity system ( P system)
Fixed order quantity system (Q system)
⚫ Whenever the stock level touches the reorder level an
order is placed for a fixed quantity which is equal to
EOQ
Reserve & safety stocks
⚫ Safety stock : Stock kept to counter the variation in

⚫
demand during lead time
Reserve stock : Stock kept to counter the average
demand during delivery delays
Basis for Setting the Re-Order Point
⚫ In the fixed order quantity system, the ordering
process is triggered when the inventory level drops to

⚫
a critical point, the Re-order point

⚫
This starts the lead time for the item.
Lead time is the time to complete all activities
associated with placing, filling and receiving the order.
Basis for Setting the Re-Order Point
⚫ During the lead time, customers continue to draw

⚫
down the inventory
It is during this period that the inventory is

⚫
vulnerable to stockout (run out of inventory)
Customer service level is the probability that a
stockout will not occur during the lead time
Basis for Setting the Re-Order Point
⚫ Thus, the order point is set based on
⚫ the demand during lead time (DDLT) and
⚫
⚫
the desired customer service level
Re-Order point = Expected demand during lead time

⚫
+ Safety stock (SS)
The amount of safety stock needed is based on the
degree of uncertainty in the DDLT and the customer

⚫
service level desired
Incase of delivery delays
⚫ Reorder point = Demand during lead time + safety
stock + reserve stock
Periodic review system ( P system)
⚫ Stock position is reviewed once in a fixed period and

⚫
an order is placed depending on the stock position
The review period is approximately = EOQ / D,

⚫
where D is the annual demand
Instead of reorder level, here desired maximum
inventory level is calculated
P system schematic representation

Maximum Inventory level = Safety stock during lead time &


review period+ reserve stock + demand during lead time &
review period
Sample numerical on EOQ
⚫ Find total annual inventory cost, EOQ and reorder
points (units) based on the following information
⚫ Weekly demand (units) 240
⚫ Operating time (weeks) 52
⚫ Annual demand (units) 12480
⚫ Ordering cost 50.00
⚫ Annual holding cost (%) 20%
⚫ Unit cost 15.00
⚫ Annual holding cost / unit 3.00
⚫ Lead time (weeks) 2
Sample numerical solution
⚫
⚫ EOQ =
First calculate EOQ
2 x Annual Consumption (units)X Ordering cost (per order)
Carrying (holding)cost per unit

Carrying (holding) cost per unit = Cost per unit X Carrying cost(%)

⚫ EOQ = 2 x 12480 x 50 = 644.98 = 645


3
⚫ Re order point = average demand during lead time +
safety stock
= (240 x 2 ) + 0 = 480 units
i.e. No. of orders = Total demand / EOQ = 12480 /645 = 19

Total inventory cost = total inventory carrying cost + total


ordering cost
Total inventory cost = (12480 x 15 x 20/100) +(19 x50)
= 37,440 + 950
= 38,390

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