Cm Report Lalit.docx

Economic Order Quantity Model

Table of content

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Content

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1

Introduction

2

2

The EOQ formula derivation

3

3

Assumptions Of EOQ Model

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4

Advantages of EOQ

5

5

Limitations of Using EOQ

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6

Conclusion

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Reference

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Economic Order Quantity Model

INTRODUCTION The EOQ has been previously defined by Dervitsiotis (1981), Monks (1996), Lucey (1992), and Schroeder (2000) as the ordering quantity which minimizes the balance of cost between inventory holding cost and reorder costs. Lucey (1992) stressed further that to be able to calculate a basic EOQ. What Would Holding and Ordering Costs Look Like for the Years?

A = Demand for the year Cp = Cost to place a single order Ch = Cost to hold one unit inventory for a year Total Relevant* Cost (TRC) Yearly Holding Cost + Yearly Ordering Cost

* “Relevant” because they are affected by the order quantity Q Economic Order Quantity (EOQ)

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Economic Order Quantity Model

The EOQ formula is given below; it’s derivation EOQ = 2CoD/ Cc … (1) Where Co, Cc and D denote the ordering costs, carrying cost and annual demand respectively. Annual Stock = Q/2, Total annual carrying cost = CcQ/2, Number of orders per annum = D/Q, Annual Ordering Costs = CoD/Q And Total Cost = CcQ/2 + CoD/Q … (2) In the above formula, Q is defined as the result of the calculated EOQ.The order quantity, which makes the total cost (TC) at a minimum, is obtained by differentiating with respect to Q and equating the derivative to zero the above total cost equation 2. Thus, dTc/dQ = Cc/2 – CoD/Q2 and when dTc/dQ = 0 cost is at minimum. DCo/Q2 = Cc/2 Q2 = 2DCo / Cc and Q which represent the EOQ formula

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Economic Order Quantity Model Assumptions Of EOQ Model I.

Constant or uniform demand– although the EOQ model assumes constant demand, demand may vary from day to day. If demand is not known in advance- the model must be modified through the inclusion of safe stock.

II.

Constant unit price– the EOQ model assumes that the purchase price per unit of material will remain unaltered irrespective of the order offered by the suppliers to include variable costs resulting from quantity discounts, the total costs in the EOQ model can be redefined.

III.

Constant carrying costs– unit carrying costs may very substantially as the size of the inventory rises, perhaps decreasing because of economies of scale or storage efficiency or increasing as storage space runs out and new warehouses have to be rented.

IV.

Constant ordering cost– this assumption is generally valid. However any violation in this respect can be accommodated by modifying the EOQ model in a manner similar to the one used for variable unit price.

V.

Instantaneous delivery– if delivery is not instantaneous, which is generally the case; the original EOQ model must be modified through the inclusion of a safe stock.

VI.

Independent orders– if multiple orders result in cost saving by reducing paper work and the transportation cost, the original EOQ model must be further modified. While this modification is somewhat complicated, special EOQ models have been developed to deal with it.

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Economic Order Quantity Model Advantages of EOQ 1. Avoids over purchasing

2. Devoted attention on only thse items that are required

3. Positive control can be easily exerted to maintain tota inventory investment at a desired level, simply by manipulating the plant maximum and minimum levels

4. Unnecessary storage of the raw material is avoided

5. EOQ avoids running out of stock

6. Ensues pre-decided delivery dates

7. EOQ avoids effects like proce fluctuations and shortage of material in the market

8. Material shortage and excess material situation can be avoided

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Economic Order Quantity Model Limitations of Using EOQ The EOQ formula inputs make an assumption that consumer demand is constant. The calculation also assumes that both ordering and holding costs remain constant, which makes it difficult or impossible for the formula to account for business events such as changing consumer demand, seasonal changes in inventory costs, lost sales revenue due to inventory shortages, or purchase discounts a company might get for buying inventory in larger quantities.

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Economic Order Quantity Model

Conclusion Inventory management helps to meet the rising challenges in most corporate companies. Through a wellbuiltpolicy organization is able to handle its idle stock without incurring unnecessary costs. A basis forinventory planning and control was also provided in this study. The study suggests to rectify certain defects in the company inventory policy and if these suggestion are implemented, the company's inventory management situation will attain a greater height. Economic order quantity model useful to maintain an optimal level of materials in store, the level that minimizes total cost of investment in inventory. Inventory levels can be a useful indication of what level of sales to expect

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Economic Order Quantity Model

Reference

 Erlenkotter, D. (1989) “An Early Classic Misplaced: Ford W. Harris's Economic Order Quantity Model of 1915,” Management Science 35:7, pp. 898–900.  Federgruen, A. and Y. S. Zheng. (1992) “An Efficient Algorithm for Computing an Optimal (r,Q) Policy in Continuous Review Stochastic Inventory Systems,” Operations Research 40:4, pp. 808–813.  Gallego, G. (1998) “New Bounds and Heuristics for (Q,r) Policies,” Management Science 44:2, 219–233.  Harris, F. M. (1913) “How Many Parts to Make at Once,” Factory, The Magazine of Management 10:2, 135–136, 152. Reprinted in Operations Research 38:6 (1990), 947–950.  Lowe, T. J. and L. B. Schwarz. (1983) “Parameter Estimation for the EOQ Lot-Size Model: Minimax and Expected-Value Choices,” Naval Research Logistics Quarterly, 30, 367–376.  Schwarz, L. B. (1972) “Economic Order Quantities for Products with Finite Demand Horizons,” AIIE Transactions 4:3, 234–237.  Zheng, Y. S. (1992) “On Properties of Stochastic Inventory Systems,” Management Science 38:1, 87–103  Zipkin, P. (2000) Foundations of Inventory M anagement, McGraw-Hill Higher Education, New York, New York.

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