Republic of the Philippines

UNIVERSITY OF RIZAL SYSTEM

Binangonan, Rizal

GRADUATE SCHOOL
COURSE SYLLABUS
1st Semester, SY 2022-2023

BA 201: Quantitative Business Analysis

Riclyn D. Moscosa

Topic: Inventory – The Economic Order Quantity

Professorial Lecturer: Dr. Floricel Ulat

Learning Objectives:
● Understand the importance of inventory control.
● Use the economic order quantity (EOQ) to determine how much to order.
● Compute the reorder point (ROP) in determining when to order more inventory.

What is Inventory?

Inventory is any stored resource that is used to satisfy a current or future need. This is one of
the most expensive and important assets of a company. Raw materials, work in process and
finished goods are the examples of inventory. As such, inventory planning and control is one of
the most challenging parts of the business wherein companies must make balance between low
and high inventory levels. Since the objective of most businesses is to minimize cost and
maximize profit, inventory levels should be considered as these would entail various cost to the
organization. However, demand from customers should also be considered to prevent customer
dissatisfaction when ran out of stock/inventory i.e., stockouts.

Inventory Planning and Control

Planning Phase: concerned primarily with what inventory is to be stocked and how it is to be
acquired whether to be manufactured or purchased
Forecasting Phase: forecast demand for the product/inventory.
Controlling Phase: maintaining adequate inventory levels within an organization.
Importance of Inventory Control

Inventory control serves several important functions and adds a great deal of flexibility to the
operation of the firm. The following were some of the uses of inventory control

1. Decoupling Function: If you did not store inventory, there could be many delays and
inefficiencies. Thus, inventory can act as a buffer.

2. Storing Resources: Any resource, physical or otherwise can be stored in inventory.

3. Irregular Supply and Demand: When the supply or demand for an inventory item is irregular,
storing certain amounts in inventory can be important.

4. Quantity Discounts: Suppliers offer discount for large orders.

5. Avoiding stockouts and shortages: If you are repeatedly out of stock, customer are likely to go
elsewhere to satisfy their needs. Lost goodwill can be an expensive price to pay for not having
the right item at the right time.

Inventory Decisions

When controlling inventory, there are two decisions to be made:

1. How much to order?
2. When to order?

The purpose of all inventory models and techniques is to determine rationally how much and
when to order. Since inventory fulfills many important functions within an organization, however,
when inventory levels go up, the cost of storing and holding inventory also increases. Hence,
every organization much reach a fine balance in establishing inventory levels. A major objective
of controlling an inventory is to minimize the total inventory costs.

Significant inventory costs:

1. Cost of the items (purchase cost or material cost)
2. Cost of ordering
3. Cost of carrying, or holding, inventory
4. Cost of stockouts
ECONOMIC ORDER QUANTITY (EOQ): HOW MUCH TO ORDER

The economic order quantity (EOQ) is one of the oldest and most commonly known inventory
control techniques. It is a company’s optimal order quantity for minimizing its total costs related
to ordering, receiving and holding inventory. This production-scheduling model was developed
in 1913 by Ford W. Harris and has been refined over time. The formula assumes that demand,
ordering, and holding costs all remain constant.

The most important assumptions in using this inventory model are as follows:

1. Demand is known and constant.

2. The lead time—that is, the time between the placement of the order and the receipt of the
order—is known and constant.
3. The receipt of inventory is instantaneous. In other words, the inventory from an order
arrives in one batch, at one point in time.
4. The purchase cost per unit is constant throughout the year. Quantity discounts are not
possible.
5. The only variable costs are the cost of placing an order, ordering cost, and the cost of
holding or storing inventory over time, holding or carrying cost. The holding cost per unit
per year and the ordering cost per order are constant throughout the year.
6. Orders are placed so that stockouts or shortages are avoided completely.

TOTAL COST AS A FUNCTION OF ORDER QUANTITY

The lowest point on the total cost curves occurs where the ordering cost is equal to the carrying
cost. Thus, to minimize total costs given this situation, the order quantity should occur where
these two costs are equal.
FORMULAS:

SAMPLE PROBLEM:
Sumco, a company that sells pump housings to other manufacturers, would like to reduce its
inventory cost by determining the optimal number of pump housings to obtain per order. The
annual demand is 1,000 units, the ordering cost is $10 per order, and the average carrying cost
per unit per year is $0.50.
Using these figures, if the EOQ assumptions are met, calculate the optimal number of units per
order.
Finding the total annual inventory cost:

SENSITIVITY ANALYSIS WITH THE EOQ MODEL

The EOQ model assumes that all input values are fixed and known with certainty. However,
since these values are often estimated or may change over time, it is important to understand
how the order quantity might change if different input values are used. Determining the effects
of these changes is called sensitivity analysis.

Assuming, we increased the ordering cost (Co) from $10 to $40

Therefore, the EOQ changes by the square root of a change in any of the inputs.

CONCLUSION

Economic order quantity is important because it helps companies manage their inventory
efficiently. Without inventory management techniques such as these, companies will tend to
hold too much inventory during periods of low demand while also holding too little inventory
during periods of high demand. Either problem creates missed opportunities.

REFERENCES
Quantitative Analysis for Management 2012 - BARRY RENDER & RALPH M. STAIR, JR. &
MICHAEL E. HANNA
https://www.investopedia.com/terms/e/economicorderquantity.asp