Economic Order Quantity

By : Raman Preet Singh

Definitions • Inventory-A physical resource that a firm holds in stock with the intent of selling it or transforming it into a more valuable state. • Inventory System- A set of policies and controls that monitors levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be

Inventory Def. A physical resource that a firm holds in stock with the intent of selling it or transforming it into a more valuable state. • Raw Materials • Works-in-Process • Finished Goods • Maintenance, Repair and Operating (MRO)

Expensive Stuff • The average carrying cost of inventory across all mfg.. in the U.S. is 30-35% of its value. • What does that mean? • Savings from reduced inventory result in increased profit. • Average Aggregate Inventory Value: How much of the company’s total assets are invested in inventory? • Ford:6.825 billion

Methods of Inventory Management • • • • • • •

ABC classification VED classification HML classification SDE FSN EOQ JIT

ECONOMIC ORDER QUANTITY  What should be the size of the order? • Small orders result in: – low inventory levels & carrying costs – frequent orders & higher ordering costs • Large orders result in: – higher inventory levels & carrying costs – infrequent orders & lower ordering costs

• EOQ or Opt Q is the order quantity at which the total cost , comprising ordering cost plus carrying cost is the least.

Typical assumptions made… – Annual demand (D), carrying cost (C) and ordering cost (S) can be estimated – Demand for the product is constant and uniform throughout the year – Demand occurs at a uniform rate – Orders are received all at once – Ordering costs are constant – Acquisition cost is fixed, i.e., no quantity discounts – Price per unit of product is constant

Graphical presentation of EOQ TOTAL COST

Cost

CARRYING COST (Q/2)H

EOQ Order Quantity Size Q

ORDERIN G COST DS/Q

ECONOMIC ORDER QUANTITY • How to find the OPTIMAL QUANTITY or EOQ? • Q=

2DCo/Ch

D = annual demand Co = ordering/setup costs Ch = cost of holding one unit of inventory

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An auto industry purchases spark plugs at the rate of Rs. 25 per piece. The annual consuption of spark plug is 18,000 units. If the ordering cost is Rs. 250 per order and carrying cost is 25% p. a. What would be the EOQ?  Calculation of EOQ: Annual demand (D) = 18000 units Unit price (P) = Rs.25 Ordering cost per order (C0) = Rs.250 Carrying charges in % = 25% p. a. Carrying charges per unit (Ch) = Rs 25 * .25 = Rs 6.25

EOQ

=

2 *D *C0 Ch

2*18000*250 6.25 = 1200 units. =