Factors

1. Average rate of consumption of materials

2. Time needed to obtain new supplies

3. Amount of obsolescence available

4. Availability of storage space

5. EOQ

6. Cost of carrying inventory

Formula of maximum stock level =Re order level+ Re-order quantity-[Minimum consumption per day or
per week x Minimum time required for delivery]

or

Maximum stock level=Re order level-Consumption during the time required to get supplies at minimum
rate+Economic order size

Example ABC is a product manufactured from the three raw materials. M,N, AND Q. Each unit of abc
requires 10kg, 8 kg and 6 kg of m , n, and q respectively.

The re order levels of M and N are 15,000kg and 10,000 kg respectively. The minimum re-order of Q is
25,000 kg.

The weekly production of ABC varies from 300 to 500 unit.; while the weekly average production is 400
units.

Req,1.

Determine the minimum stock level of M

Req.2.

Maximum stock level of N

Req.3.

Determine the re-order level of Q

Solution:

Req.1

Minimum stock level of M

=Re-order level-[Normal consumption per week X Average time required to obtain supplies]

=15,000kgs-[400 units x 10kgs x 3 weeks], Minimum delivery time 2 weeks, Maximum delivery time 4
weeks

=15,000-12,000

=3,000 kgs

Req.2.

Req.2.Maximum stock level of N

=Re-order level+ Re-order quantity-[Minimum consumption per week x Minimum time required to
obtain the supplies]

Re-order quantity 15,000 kgs; minimum time required 4 weeks

=10,000 kg+15,000 kg-[300 units x 8 kg x 4 weeks]

=15,400 kgs

Required 3

Re-order level of Q

=Maximum Consumption per week x Maximum time required to obtain supplies

Minimum Delivery time 3 weeks

Maximum delivery time 5 weeks

Average delivery time 4 weeks

=500 units x 6 kg x 5 weeks

=15,000 kgs
Lead time is the sum of the time required to place a replenishment order and for a supplier to deliver
the ordered goods. A business must maintain a sufficient amount of inventory on hand to keep it from
running out before the replenishment order arrives.

Economic order quantity (EOQ) is a calculation companies perform that represents their ideal order size,
allowing them to meet demand without overspending. Inventory managers calculate EOQ to minimize
holding costs and excess inventory

EOQ-Factors

1. Reorder Point
It is the time when there occurs a need to reorder another set of stock or replenish the existing stock.
EOQ always assumes that you order the same quantity at each reorder point.

2. Purchase order lead time

This is the time period from placing the order until the ordering is delivered. EOQ assumes that the lead
time is understood.

3. Purchasing cost per unit

The cost per unit never changes, over the period of time, even though the quantity of the order is
changed. EOQ always assumes that you pay the same amount per product, every time.

4. Stockouts
There are no chances for stockouts. You have to always maintain enough inventory to avoid stockout
costs. This clearly states that you always have to strictly monitor your customer demand along with your
inventory levels, carefully.

5. Quality costs
EOQ never focuses on the quality costs, rather the carrying costs.

6. Demand
It’s about how much the customer wants the product for a specific time period.

7, Relevant ordering cost

The cost per purchase order.

8. Relevant carrying cost

The cost involved in the entire maintenance and carrying the stock, for the specific period.

Importance of Economic Order Quantity (EOQ)

The Economic Order Quantity is a quantity designed to assist companies to not over- or under-stock
their inventories and minimize their capital investments on the products that they are selling. The cost
of ordering an inventory touches down with an increase in ordering in bulk. However, as the seller
wishes to grow the size of the inventory, the carrying costs also increase.

The EOQ is exactly the point that optimizes both of these costs i.e. cost of ordering and the carrying
costs which are inversely related.

Now, with this…

The business owners can easily order the right quantities and reduce the ordering and carrying costs.
This will eventually result in either profits or a balanced business.
Decision making can be made smoother, with less time and effort wasted.
Right vendors can be chosen, with the right packages to save costs and earn better profits.

1. Holding costs (H)

Holding cost (also known as carrying costs) refers to the total cost of holding inventory. Minimizing
inventory costs is an important retail supply chain management strategy.

2. Order cost (S)

Also referred to as ‘setup cost,’ how much does an order cost per purchase? This is done on a per-order
basis and includes both the shipping and handling costs.

3. Annual demand (D)

How much demand do you get for a product each year? By looking into historical order data, you can
determine how much product you sell year over year..

The economic order quantity formula

The formula for economic order quantity is:

EOQ = square root of: [2SD] / H

S = Setup costs (per order, generally including shipping and handling)

D = Demand rate (quantity sold per year)

H = Holding costs (per year, per unit)

Let’s say you have these variables:

$0.75 in holding costs per unit = H

Demand rate of 10,000 per year = D
Setup cost of $500 = S

EOQ = square root of (2)(500)(10,000)/.75) = 3,652 units per order.

Optimal order quantity is 3,652 units for that specific product.

Question

Annual consumption 40,00,000 kgs

Cost of pacing one order $100

Cost of carrying one kg of Raw material for one year $0.50

EOQ = square root of: [2SD] / H

=40,000 units

Example

The annual demand for a product is 6,400 units; The unit cpst is $6 and the inventory carrying cost is
25% per annuam.

Req.1

calculate the EOQ

IF THE COST TO PROCURE ONE UNIT IS $75

EOQ = square root of: [2SD] / H

=40,000 UNITS

square root of 2 X 6,400 X75/1.50

REQ.2,

DETERMINE THE NUMBER OF ORDERS PER YEAR

=ANNUAL CONSUMPTION/sIZE OF ONE ORDER

IF THE SIZE OF ONE ORDER 800 UNITS

=6,400 UNITS/800 UNITS

=8 ORDERS
REQ.3

TIME GAP BETWEEN THE TWO CONSECUTIVE ORDERS

=12 MONTHS/ NUMBER OF ORDERS

=12 MONTHS/8 ORDERS

=1.50 MONTHS