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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

& 
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 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
2(10) (5200)
C = $10 per order EOQ =
(2 )(.20)
P = $2
F = 20% of value of
inventory per year
Real Life Example:

2(10) (5200)
EOQ =
(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