Economic Order Quantity Bus M361-2 Sabrina Wu 11/28/2005.

Economic Order Quantity

Bus M361-2

Sabrina Wu

11/28/2005

Economic Order QuantityDefinition of EOQHow to use the EOQ model in a

business organizationHow the EOQ model worksReal 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

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The Principles Behind EOQ: The Total Cost Curve

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 unitR = Forecasted monthly usage

How EOQ Works

The Total Cost Formula

This represents the variable order costs

P = Purchase cost per unitR = Forecasted monthly usageC = 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 unitR = Forecasted monthly usageC = Cost per order event (not per unit)Q = The number of units orderedF = 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:

The result of differentiation

How EOQ Works

The EOQ Formula

The Economic Order Quantity

How EOQ Works

The EOQ Formula

Review and Summary of the EOQ Formula

P = Purchase cost per unitR = Forecasted monthly usageC = 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 unitR = Forecasted monthly usageC = Cost per order event (not per unit)F = Holding cost factor

Real Life Example:

Next let’s identify the correct variables…

Real Life Example:

Next let’s identify the correct variables…

Forecasted Amount

Real Life Example:

Next let’s identify the correct variables…

Ordering Costs

Real Life Example:

Next let’s identify the correct variables…

Cost per Unit

Real Life Example:

Next let’s 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