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Economic Order Quantity

The document discusses the economic order quantity (EOQ) model, which is used to determine the optimal order quantity that minimizes total inventory costs. The EOQ model balances ordering costs and carrying costs. It assumes constant demand, costs, and lead times. The optimal order quantity (Q*) is calculated as the square root of two times ordering costs times annual demand divided by carrying costs. The EOQ model can also incorporate shortage costs to determine the optimal order quantity when shortages are allowed.

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Abegail Castillo
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102 views22 pages

Economic Order Quantity

The document discusses the economic order quantity (EOQ) model, which is used to determine the optimal order quantity that minimizes total inventory costs. The EOQ model balances ordering costs and carrying costs. It assumes constant demand, costs, and lead times. The optimal order quantity (Q*) is calculated as the square root of two times ordering costs times annual demand divided by carrying costs. The EOQ model can also incorporate shortage costs to determine the optimal order quantity when shortages are allowed.

Uploaded by

Abegail Castillo
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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ECONOMIC ORDER

QUANTITY
( EOQ )
 One of the most commonly known inventory control
techniques.

 In general, when an order arrives the inventory level


increases.

 It is the order quantity that minimizes total holding


costs and ordering costs.
BASIC INVENTORY COST
Carrying cost
 Cost occurred by a business for holding items in
inventory
 It includes product obsolescence, deferred profit on
investment, depreciation taxes and insurance etc…
Ordering cost
 Costs a business incurs when it makes an order
to replenish its inventory.
 It includes transportation cost, salaries, cost of
unloading orders and etc…
EOQ MODEL’S ASSUMPTIONS
 Demand, unit cost, and the length of time needed
to order and replenish the inventory are known
and constant
 Items are withdrawn from inventory at a uniform
rate
 Orders are placed for a constant amount and at
the right time to avoid any shortages
 An order arrives per batch at one point in time
and is directly placed in inventory
AVERAGE INVENTORY LEVEL
- is the amount of inventory available

average inventory = Q / 2

Where,
Q = Order size
ORDERS PER YEAR
- Total ordering costs is derived from the
number of orders that will be made during the
year.

=D/Q
Where,
D = demand per year
Q = order size
TOTAL ANNUAL ORDERING COST
- number of orders per year multiplied by the
costs per order.

= Co ( D/Q )
Where,
Co = ordering cost
TOTAL INVENTORY COST
- computed by summing total annual
carrying cost and total annual ordering cost.

= Cc ( Q/2 ) + Co ( D/Q )
Where,
Cc = carrying cost
OPTIMAL Q
- occurs when the total cost curve is lowest
and where total ordering cost equals total carrying
cost

Q= 2CoD / Cc
REORDER POINT
- computed by multiplying the lead time by
the demand per day.

R = L ( D / 365 )

Where,
R = reorder point
L = lead time
AVERAGE INVENTORY

No. of days to receive an order = Q / r

Where,
r = daily rate of replenishment of inventory
DAILY DEMAND RATE

d = annual demand / 365 days


DEMAND DURING THE ORDER RECEIPT
PERIOD

=(Q/r)d
MAXIMUM INVENTORY LEVEL

=Q–(Q/r)d
AVERAGE INVENTORY LEVEL

= Q / 2 ( 1 – ( d / r))
TOTAL CARRYING COST

= Cc ( Q /2 ) (1- (d /r))
TOTAL ANNUAL INVENTORY COST

= Co(D/Q) + Cc(Q/2)(1-(d/r))
OPTIMAL Q*

Q* = 2CoD / Cc ( 1- (d/r ))
EOQ MODEL WITH SHORTAGES AND
BACK ORDERING

it is often economical to allow shortages and


back order demand and incur the cost associated
with not being able to meet demand than keep an
excessive amount of inventory on hand to avoid
shortages.
ADDING SHORTAGES COST

Total Shortage cost = Cs ( S^2 / 2Q )

A shortage cost must be added in order to develop an EOQ


Model that includes shortages.
Thank You!

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