Economic Order Quantity (EOQ):
Learning Objective:
- Definite and explain economic order
quantity (EOQ).
- How is economic order quantity (EOQ)
calculated?
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Definition of EOQ
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Formula
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Example:
Economic order quantity (EOQ) is that size of
the order which gives maximum economy in purchasing any material and
ultimately contributes towards maintaining the materials at the optimum
level and at the minimum cost.
In other words, the economic order quantity
(EOQ) is the amount of inventory to be ordered at one time for purposes of
minimizing annual inventory cost.
The quantity to order at a given time must be
determined by balancing two factors: (1) the cost of possessing or carrying
materials and (2) the cost of acquiring or ordering materials. Purchasing
larger quantities may decrease the unit cost of acquisition, but this saving
may not be more than offset by the cost of carrying materials in stock for a
longer period of time.
The carrying cost of inventory may include:
- Interest on investment of working capital
- Property tax and insurance
- Storage cost, handling cost
- Deterioration and shrinkage of stocks
- Obsolescence of stocks.
The different formulas have been developed for
the calculation of economic order quantity (EOQ). The following formula is
usually used for the calculation of EOQ.
- A = Demand for the year
- Cp = Cost to place a single order
- Ch = Cost to hold one unit inventory for a year
- * = ×
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Pam runs a mail-order business for gym
equipment. Annual demand for the TricoFlexers is 16,000. The annual
holding cost per unit is $2.50 and the cost to place an order is $50.
Calculate economic order quantity (EOQ)
Calculation:
Underlying Assumptions of Economic Order Quantity:
- 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.
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