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Home Materials and Inventory Cost Control Economic Order Quantity (EOQ)

 

Economic Order Quantity (EOQ):

Learning Objective:

  1. Definite and explain economic order quantity (EOQ).
  2. How is economic order quantity (EOQ) calculated?
  1. Definition of EOQ
  2. Formula
  3. Example:

Definition and Explanation:

Economic order quantity (EOQ) is that size of the order which gives maximum economy in purchasing any material and ultimately contributes towards maintaining the materials at the optimum level and at the minimum cost.

In other words, the economic order quantity (EOQ) is the amount of inventory to be ordered at one time for purposes of minimizing annual inventory cost.

The quantity to order at a given time must be determined by balancing two factors: (1) the cost of possessing or carrying materials and (2) the cost of acquiring or ordering materials. Purchasing larger quantities may decrease the unit cost of acquisition, but this saving may not be more than offset by the cost of carrying materials in stock for a longer period of time.

The carrying cost of inventory may include:

  • Interest on investment of working capital
  • Property tax and insurance
  • Storage cost, handling cost
  • Deterioration and shrinkage of stocks
  • Obsolescence of stocks.

Formula of Economic Order Quantity (EOQ):

The different formulas have been developed for the calculation of economic order quantity (EOQ). The following formula is usually used for the calculation of EOQ.

Economic Order Quantity-EOQ-Formula

  • A  =  Demand for the year
  • Cp   =  Cost to place a single order
  • Ch  =  Cost to hold one unit inventory for a year
  • * =

Example:

Pam runs a mail-order business for gym equipment.  Annual demand for the TricoFlexers is 16,000.  The annual holding cost per unit is $2.50 and the cost to place an order is $50. 

Calculate economic order quantity (EOQ)

Calculation:

Economic Order Quantity-EOQ-Example-Problem

Underlying Assumptions of Economic Order Quantity:

  1. The ordering cost is constant.
  2. The rate of demand is constant
  3. The lead time is fixed
  4. The purchase price of the item is constant i.e no discount is available
  5. The replenishment is made instantaneously, the whole batch is delivered at once.

You may also be interested in other articles from "materials and inventory cost control" chapter.

  1. Need for Materials Control
  2. Requirements of a System of Materials control
  3. Stock Control
  4. Ordering Level or Ordering Point or Re-order Level
  5. Minimum Level or Minimum Limit
  6. Maximum Level or Maximum Limit
  7. Danger Level
  8. Economic Order Quantity EOQ

 

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