Financial Management

Niranjan
BBA 3C
115
 What is EOQ?
• Economic order quantity (EOQ) is the fixed quantity of material which
is ordered when the stock comes down to a reorder level.
• EOQ is at the optimum level when the total of ordering costs and
carrying costs is minimum.
• It is the point where ordering costs equal the carrying costs.
• Ordering costs include costs incurred on requisitioning, purchase
ordering, transporting, receiving, inspecting and storing. It has direct
relationship with number of orders placed.
• Carrying cost includes storage, insurance, taxes, clerical and staff
service costs, costs of deterioration and obsolescence, etc.
 How to calculate EOQ?
• Two methods to calculate :

1) Order formula approach

2) Graphic approach.
 Order formula approach
• Order formula approach :
2𝐴𝑂
EOQ = Where, A is total requirement annually, O is the
𝐶
ordering cost per unit and C is carrying cost per unit annum.
• This formula is based on three assumptions:
1. Price will remain constant throughout the year and quantity discount is
not involved.
2. Pattern of consumption, variable ordering costs per order and variable
inventory carrying charge per unit annum will remain the same throughout.
3. EOQ will be delivered each time the stock balance is just reduced to nil.
 Graphic Approach
• In the graphical approach : Carrying costs , Ordering costs and Total
costs – are plotted on vertical axis. Horizontal axis is used to
represent the order size. The EOQ occurs at the point where total
cost is minimum.
 Reorder Quantity
• The reorder point is the level of inventory which
triggers an action to replenish that particular
inventory stock. It is a minimum amount of an
item which a firm holds in stock, such that, when
stock falls to this amount, the item must be
reordered.
 Safety Stock
Safety stock is an additional quantity of an item
held in inventory in order to reduce the risk that
the item will be out of stock. Safety Stock acts as a
buffer in case the sales of an item are greater
than planned and/or the supplier is unable to
deliver additional units at the expected time .
Thank You
NIRANJAN