Economic Order Quantity

Presented by : Rajneesh

Ranjan

IntroductionEconomic order quantity is the level of inventory that minimizes the total inventory holding costs and ordering costs. The framework used to determine this order quantity is also known as Wilson EOQ Model. The model was developed by F. W. Harris in But still R. H. Wilson is given credit for his early in-depth analysis of the model.

The Definition of EOQ

EOQ, or Economic Order Quantity, is defined as the optimal quantity of orders that minimizes total variable costs required to order and hold inventory.

How to use EOQ in organizationHow 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.

How EOQ Works The Principles Behind EOQ

Interest

Obsolescence

Storage

How EOQ Works

&

The Principles Behind EOQ: The Total Cost Curve

How EOQ Works The Principles Behind EOQ: The Holding Costs

Keeping inventory on hand

Interest

Insurance

Taxes

Theft

Obsolescence

Storage Costs

Order Quantity SizeOrder Quantity Size

Co

st(R

s)C

ost

(Rs)

Carrying costCarrying cost

EOQ Model

Order Quantity sizeOrder Quantity size

Co

st(R

s)C

ost

(Rs)

Carrying costCarrying cost

Ordering costOrdering cost

EOQ Model

Order Quantity sizeOrder Quantity size

Co

st(R

s)C

ost

(Rs)

Carrying costCarrying cost

Ordering CostOrdering Cost

EOQ Model

Total cost curve

Order QuantityOrder Quantity

Carrying costCarrying cost

Total Cost CurveTotal Cost Curve

Ordering CostOrdering Cost

EOQ Model C

ost

(R

s)C

ost

(R

s)

EOQ

How EOQ Works The EOQ Formula

P = Purchase cost per unitR = Forecasted monthly usageC = Cost per order event (not per unit)F = Holding cost factor

Example: Q. Calculate the economic order quantity if annual demand for the product is 5,000 unit. The ordering cost is Rs 30 per order and holding cost is Rs 6/- per unit per annual.

Sol:- Given R=5000 unit

C= Rs. 30

H=Rs. 6

Now, _____

EOQ = √(2CR/H)

_____

= √(2*5000*30/6)

______

= √ 50000

= 223.6

≈ 224

Total No of events per year(order per year) = 5000/224= 22.32≈ 23

EOQ Assumptions Demand is assumed to be known with certainly.

The size of each order is constant.

The procurement cost is assumed to be linearly

related to the number of order.

The time between placement of the order and the

receipt of the order is known and constant.

The receipt of inventory is instantaneous

the cost of the placing an order and the cost of

holding or storing inventory overtime.

Advantages of EOQ EOQ is the order quantity that minimizes total

holding and ordering costs for the year. EOQ technique is highly useful in as much it

answers the question of how much to order. An inventory-related equation that determines the

optimum order quantity . EOQ may not apply to every inventory situation,

but most organizations will find it beneficial in at least some aspect of their operation.

Weakness of EOQ formula Erratic usages

Faulty Basic Information Costly Calculations No formula is Substitute for commonsense EOQ ordering must be tempered with judgment Materials Requirement Planning (MRP) The cost assumptions are rational and are not

found in real life, unit cost of purchased varies in practice.

The lead time is not constant, the demand is erratic.

References:

1) Khanna, Dr O.P. and Sarup, A. (2003), Industrial Engineering and Management, Dhanpat Rai Publications (P) Ltd, New Delhi

2) Badi, R.V. and Badi, V.N. (2005), Modern Production Management, Vrinda Publication, New Delhi.

3) Chunawalla, S.A. and Patel, D.R. (2008), Production and Operation Management, Himalaya Publication, Mumbai.

4) http://en.wikipedia.org, viewed on 04 Feb. 2010

5) http://managementhelp.org, viewed on 04 Feb. 2010

Thank you