Economic Order Quantity

Bus M361-2 Sabrina Wu 11/28/2005

Economic Order Quantity

Definition of EOQ How to use the EOQ model in a business organization How the EOQ model works Real world example

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 your organization

How 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: The Total Cost Curve

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How EOQ Works

The Principles Behind EOQ: The Holding Costs Keeping inventory on hand Interest

Insurance
Taxes Theft Obsolescence Storage Costs

How EOQ Works

The Principles Behind EOQ: The Holding Costs

Interest

Obsolescence
Storage

How EOQ Works

The Principles Behind EOQ: The Procurement Costs Primarily the labor costs associated with processing the order:

Ordering and requisition

A portion of the freight if the amounts vary according to the size of the order

Receiving, inspecting, stocking

Invoice processing

How EOQ Works

The Total Cost Formula

Total Cost = Purchase Cost + Order Cost + Holding Cost

How EOQ Works

The Total Cost Formula

This represents the unchanging fixed costs

P = Purchase cost per unit R = Forecasted monthly usage

How EOQ Works

The Total Cost Formula

This represents the variable order costs

P = Purchase cost per unit R = Forecasted monthly usage C = Cost per order event (not per unit) Q = The number of units ordered

How EOQ Works

The Total Cost Formula

This represents the variable holding costs

P = Purchase cost per unit R = Forecasted monthly usage C = Cost per order event (not per unit) Q = The number of units ordered F = Holding cost factor

How EOQ Works

The EOQ Formula
Total Cost Formula
Taking the derivative of both sides of the equation and setting equal to zero to find the minimum value of the function, one obtains:

How EOQ Works

The EOQ Formula
The result of differentiation

The Economic Order Quantity

How EOQ Works

The EOQ Formula
Review and Summary of the EOQ Formula

P = Purchase cost per unit R = Forecasted monthly usage C = Cost per order event (not per unit) F = Holding cost factor

How EOQ Works

The EOQ Formula
Review and Summary of the EOQ Formula Here is the a graphic representation of the EOQ equation

Real Life Example:

Real Life Example:

Real Life Example:

First, Recall the EOQ Equation:

P = Purchase cost per unit R = Forecasted monthly usage C = Cost per order event (not per unit) F = Holding cost factor

Real Life Example:

Next lets identify the correct variables

Real Life Example:

Next lets identify the correct variables
Forecasted Amount

Real Life Example:

Next lets identify the correct variables
Ordering Costs

Real Life Example:

Next lets identify the correct variables
Cost per Unit

Real Life Example:

Next lets identify the correct variables

Holding Cost Factor

Real Life Example:

R = Annual demand C = Fixed ordering cost P = Cost per case F = Holding Cost Factor

Real Life Example:

R = 5200 C = $10 per order P = $2 F = 20% of value of inventory per year

Real Life Example:

R = 5200 C = $10 per order P = $2 F = 20% of value of inventory per year

EOQ =

2 (10) (5200)

(2 )(.20)

Real Life Example:

EOQ =

2 (10) (5200)

(2 )(.20)

EOQ = 510 cases

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

Closing Comments
EOQ is a tool, not a simple solution.
EOQ is useful in determining optimal order quantity Understand the equation and what you are trying to find Find accurate inputs for the equation

Additional Resources on EOQ

http://www.findarticles.com/p/articles/mi_m0KAA/is_5_31/ ai_94771293 http://www.inventoryops.com/economic_order_quantity.htm http://en.wikipedia.org/wiki/Economic_order_quantity