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What is EOQ ?

Economic order quantity is one of the


techniques of inventory control which
minimizes total holding and ordering costs for
the year.

The economic order quantity is the technique


which solves the problem of the materials
manager.
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Assumption of the EOQ Models
Demand is known and is deterministic, i.e. constant;
The lead time, i.e. the time between placement of the
order and the receipt of the order is known and
constant;
The receipt of inventory is instantaneous. In other words
the inventory from an order arrives in one batch at one
point in time;
Quantity discount are not possible, in other words it
dose not make any difference how much we order, the
price of the product will still be the same; and
That only costs pertinent to inventory model are the
cost of placing an order and cost of holding or storing
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inventory over time.
Key Inventory Terms
• Lead time: time interval between ordering
and receiving the order
• Holding (carrying) costs: cost to carry an
item in inventory for a length of time,
usually a year
• Ordering costs: costs of ordering and
receiving inventory
• Shortage costs: costs when demand
exceeds supply
12-4
Deriving the EOQ
How much to order?:
2DS 2(Annual D em and)(Order or Setup Cost)
Q OPT = =
H Annual Holding Cost

When to order?
_
We also need a reorder R eo rd er p o in t, R = d L
point to tell us when to _
place an order
d = average daily demand (constant)
L = Lead time (constant)
EOQ MODEL
2UP
Q =
S

Q = Economic Order Quantity


U = Annual usage/demand
P = Cost of Placing an order
S = Storage cost per unit per order
* Where Storage cost is given in % , it is always calculated by
multiplying the % with the purchase price of raw material
per unit, i.e Storage cost = % X Purchase price of raw
material
EOQ
• EOQ = Square Root of 2AP/S

• Where as ,
• Q denotes order quantity;
• A denotes demand per time period (e.g.-annual
demand);
• S denotes carrying / holding cost of 1 unit of
stock for one period;
• and P denotes order cost.
EOQ Example 1 (1 of 3)

Given the information below, what are the EOQ and


reorder point?

Annual Demand = 1,000 units


Days per year considered in average daily demand = 365
Cost to place an order = $10
Holding cost per unit per year = $2.50
Lead time = 7 days
Cost per unit = $15
EOQ Example 1(2 of 3)
2D S 2(1,000 )(10)
Q O PT = = = 89.443 units or 90 u n its
H 2.50

1,000 units / year


d = = 2.74 units / day
365 days / year

_
R eo rd er p o in t, R = d L = 2 .7 4 u n its / d ay (7 d ays) = 1 9 .1 8 o r 2 0 u n its

In summary, you place an optimal order of 90 units. In the


course of using the units to meet demand, when you only have
20 units left, place the next order of 90 units.
EOQ Example 2(1 of 2)
Determine the economic order quantity
and the reorder point given the following…

Annual Demand = 10,000 units


Days per year considered in average daily demand =
365
Cost to place an order = $10
Holding cost per unit per year = 10% of cost per unit
Lead time = 10 days
Cost per unit = $15
EOQ Example 2(2 of 2)
2D S 2 (1 0 ,0 0 0 )(1 0 )
Q OPT = = = 3 6 5 .1 4 8 u n its, o r 3 6 6 u n its
H 1 .5 0

10,000 units / year


d= = 27.397 units / day
365 days / year

_
R = d L = 27.397 units / day (10 days) = 273.97 or 274 u n its

Place an order for 366 units. When in the course of


using the inventory you are left with only 274 units,
place the next order of 366 units.
EOQ- Example
• A firm’s annual inventory is 1,600 units. The cost of
placing an order is Rs 50, purchase price of raw
material/unit is Rs.10 and the carrying costs is
expected to be 10% per unit p.a. Calculate EOQ?
solution
U=1600, P= Rs. 50, S= .10 x Rs.10=Rs.1

EOQ = 2 x 1600 x 50
1

= 400 units
When to Reorder with EOQ Ordering ?
•Reorder Point – is the level of inventory at which a
new order is placed
ROP = d . L
•Safety Stock - Stock that is held in excess of
expected demand due to variable demand rate
and/or lead time.
•Service Level - Probability that demand will not
exceed supply during lead time (probability that
inventory available during lead time will meet
demand) 1 - Probability of stockout
Reorder Point Example

Demand = 10,000 yards/year


Store open 311 days/year
Daily demand = 10,000 / 311 = 32.154 yards/day
Lead time = L = 10 days

R = dL = (32.154)(10) = 321.54 yards


EOQ Example
• Weekly demand = 240 units
• No. of weeks per year = 52
• Ordering cost = $50
• Unit cost = $15
• Annual carrying charge = 20%
• Lead time = 2 weeks
EOQ Example Solution

D  52  240  12,480 units / year


H  0.2 15  $3 per unit per year
2DS 2 12,480  50
Q   644.98  645 units
H 3
 D   Q   12,480   645 
TC   S    H     50     3
 Q   2   645   2 
 967.44  967.5  $1,934.94

R  dL  240  2  480 units


EOQ
Example
You’re a buyer for SaveMart.

SaveMart needs 1000 coffee makers per year.


The cost of each coffee maker is $78. Ordering
cost is $100 per order. Carrying cost is 40% of
per unit cost. Lead time is 5 days. SaveMart is
open 365 days/yr.

What is the optimal order quantity & ROP?


SaveMart EOQ

2 D S
EOQ 
H

2 1000  $100
D= 1000

EOQ 
S= $100
C= $ 78
I=
H=
40%
CxI
$31.20
H= $31.20
EOQ = 80 coffeemakers
SaveMart ROP
ROP = demand over lead time
= daily demand x lead time (days)
=dxl

D = annual demand = 1000


Days / year = 365
Daily demand = 1000 / 365 = 2.74
Lead time = 5 days

ROP = 2.74 x 5 = 13.7 => 14


• Q. Calculate the economic order quantity if
annual demand for the product is 5,000 unit.
The ordering cost is Rs 30 per order and
holding cost is Rs 6/- per unit per annual.

• 224 or 22.5 units