ECONOMIC ORDER QUANTITY

MARIYA,SANYA,PARSIKA
UMANG,DEEPANSHU,RINKESH
INTRODUCTION

 In inventory management, economic order quantity (EOQ) is the order

quantity that minimizes the total holding costs and ordering costs.
 It is one of the oldest classical production scheduling models.
 The model was developed by Ford W. Harris in 1913, but R. H. Wilson, a
consultant who applied it extensively, and K. Andler are given credit for their
in-depth analysis.
 WHY EOQ?

 EASY TO COMPUTE.
 DOES NOT REQUIRE DATA THAT IS HARD TO OBTAIN
 POLICIES ARE SUPRISINGLY ROBUST.
 ASSUMPTIONS CAN BE RELAXED.
 GIVES A GOOD OVERALL IDEA.
 CAN BE STARTING POINT FOR SOME COMPLICATED MODELS.
IMPORTANCE

 THE EOQ IS A SET POINT DESIGNED TO HELP COMPANIES MINIMIZE THE COST OF
ORDERING AND HOLDING INVENTORY.
 THE COST OF ORDERING AND INVENTORY FALLS WITH THE INCREASE IN
ORDERING VOLUME DUE TO PURCHASING ON ECONOMIES OF SALE.
 HOWEVER AS THE SIZE OF INVENTORY GROWS , THE COST OF HOLDING THE
INVENTORY RISES.
 IT IS THE EXACT POINT THAT MINIMIZES BOTH THESE INVERSELY RELATED
COSTS.
THE EOQ FORMULAE’S
 THE EOQ FORMULA IS CALCULATED BY MINIMIZING THE TOTAL COST PER ORDER BY SETTING THE
FIRST ORDER DERIVATIVE TO ZERO.
 THE COMPONENTS OF THE FORMULA THAT MAKE UP THE TOTAL COST PER ORDER ARE THE COST
OF HOLDING INVENTORY AND THE COST OF ORDERING THAT INVENTORY.
 COMPONENTS OF EOQ FORMULA ARE –
 D : ANNUAL QUANTITY DEMANDED
 Q : VOLUME PER ORDER
 S : ORDERING COST (FIXED COST)
 C : UNIT COST (VARIABLE COST)
 H : HOLDING COST (VARIABLE COST)
 I : CARRYING COST (INTEREST RATE)
 FORMULA OF EOQ

2SD
EOQ =
H
S= ORDERING COST (FIXED COST)
D= ANNUAL QUANTITY DEMANDED
H= HOLDING COST (VARIABLE COST)
TYPES OF EOQ

 1. ORDERING COST -
THE NUMBER OF ORDERS THAT OCCUR ANNUALLY CAN BE FOUND BY
DIVIDING THE ANNUAL DEMAND BY VOLUME PER ORDER.
THE FORMULA CAN BE EXPRESSED AS :
NUMBER OF ORDERS = D/Q
FOR EACH ORDER WITH A FIXED COST THAT IS INDEPENDENT OF THE NUMBER OF
UNITS, S, THE ANNUAL ORDERING COST IS FOUND BY MULTIPLYING THE NUMBER
OF ORDERS BY THE FIXED COST. IT IS EXPRESSED AS:
ANNUAL ORDERING COST = D/Q X S
 2. HOLDING COST –
HOLDING INVENTORY OFTEN COMES WITH ITS OWN COSTS.
THIS COST CAN BE IN THE FORM OF DIRECT COST INCURRED BY FINANCING THE STORAGE OF
SAID INVENTORY OR THE OPPORTUNITY COST OF HOLDING INVENTORY OF INVESTING THE MONEY
TIED UP IN INVENTORY ELSE WHERE.
AS SUCH THE HOLDING COST PER UNIT IS OFTEN EXPRESSED AS THE COST PER UNIT MULTIPLIED BY
THE INTEREST RATE, EXPRESSED AS FOLLOWS:
H = iC
With the assumption that demand is constant, the quantity of stock
can be seen to be depleting at a constant rate over time. When
inventory reaches zero, an order is placed and replenishes
inventory as shown:

As such, the holding cost of the inventory is calculated by finding the sum
product of the inventory at any instant and the holding cost per unit. It is
expressed as follows
ANNUAL HOLDING COST = Q/2 x H
 LIMITATIONS OF EOQ

 The assumption of constant usage and the instantaneous or immediate

replenishment of inventories are not always practical.
 Safety stock is always required because deliveries from suppliers may be
delayed for reasons beyond control. Also because there may be an
unexpected demand for stocks.
 EOQ assumes that the demand is constant and known with certainty which
always is not the case. Demand may rise and fall depending upon various
factors leaving a certain degree of uncertainty behind it.
 Computational problems may arise and hence the number of orders to be
placed may not be always 100% accurate if fractions or decimals are involved.
 ASSUMPTIONS OF EOQ

 1. The firm knows with certainty how much items of particular inventories
will be used or demanded for within a specific period of time.
 2. The use of inventories or sales made by the firm remains constant or
unchanged throughout the period.
 3. The moment inventories reach to the zero level, the order of the
replenishment of inventory is placed without delay.
 4. The above assumptions are also called as limitations of EOQ model.
 EXTENTSIONS OF EOQ

 1. VOLUME TRANSPORATION RATE.

 2. QUANTITY DISCOUNT.
 3. PRODUCTION LOT SIZE.
 4. MULTIPLE ITEM PURCHASE.
 5. LIMITED CAPITAL.
 6. PRIVATE TRUCKING.
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