Premium Essay

Economic Order Quantity

In:

Submitted By williambermejo11
Words 1326
Pages 6
Economic Order Quantity (EOQ)

Economic order quantity (EOQ) is the order quantity of inventory that minimizes the total cost of inventory management.
Two most important categories of inventory costs are ordering costs and carrying costs. Ordering costs are costs that are incurred on obtaining additional inventories. They include costs incurred on communicating the order, transportation cost, etc. Carrying costs represent the costs incurred on holding inventory in hand. They include the opportunity cost of money held up in inventories, storage costs, spoilage costs, etc.
Ordering costs and carrying costs are quite opposite to each other. If we need to minimize carrying costs we have to place small order which increases the ordering costs. If we want minimize our ordering costs we have to place few orders in a year and this requires placing large orders which in turn increases the total carrying costs for the period.
We need to minimize the total inventory costs and EOQ model helps us just do that. Total inventory costs = Ordering costs + Holding costs |
By taking the first derivative of the function we find the following equation for minimum cost EOQ = SQRT(2 × Quantity × Cost Per Order / Carrying Cost Per Order) |
Example
ABC Ltd. is engaged in sale of footballs. Its cost per order is $400 and its carrying cost unit is $10 per unit per annum. The company has a demand for 20,000 units per year. Calculate the order size, total orders required during a year, total carrying cost and total ordering cost for the year.
Solution
EOQ = SQRT(2 × 20,000 × 400/10) = 1,265 units
Annual demand is 20,000 units so the company will have to place 16 orders (= annual demand of 20,000 divided by order size of 1,265). Total ordering cost is hence $64,000 ($400 multiplied by 16).
Average inventory held is 632.5 ((0+1,265)/2) which means total carrying costs of $6,325

Similar Documents

Premium Essay

Report Determination of Economic Order Quantity

...Determination of Economic Order Quantities Economic order quantity (EOQ) is that size of the order which gives maximum economy in purchasing any material and ultimately contributes towards maintaining the materials at the optimum level and at the minimum cost. In other words, the economic order quantity (EOQ) is the amount of inventory to be ordered at one time for purposes of minimizing annual inventory cost. The quantity to order at a given time must be determined by balancing two factors: (1) the cost of possessing or carrying materials and (2) the cost of acquiring or ordering materials. Purchasing larger quantities may decrease the unit cost of acquisition, but this saving may not be more than offset by the cost of carrying materials in stock for a longer period of time. The Nature of the Problem Certain purchased items in the course of producing goods and services: raw materials, supplies, and purchased parts. Some specific examples would be the coal purchased by an electric utility, the stationary purchased by an educational institution, and the tiles purchased by an automobile manufacturer. FACTORS AFFECTING ORDER QUANTITIES 1. LARGE ORDER QUANTITIES -the costs that are incurred every time an order is placed; these include the expense of placing order with a supplier, the expense of transporting the order, and the expense of receiving the incoming order. Since the expenses are relatively fixed per order, they provide the organization with an incentive to...

Words: 435 - Pages: 2

Premium Essay

Business

...shortage costs. Answer: TRUE Diff: 1 Page Ref: 744 Main Heading: Elements of Inventory Management Key words: inventory costs 4) The purpose of inventory management is to determine how much and when to order. Answer: TRUE Diff: 1 Page Ref: 746 Main Heading: Elements of Inventory Management Key words: inventory management 5) In a continuous inventory system, a constant amount is ordered when inventory declines to a predetermined level. Answer: TRUE Diff: 2 Page Ref: 746 Main Heading: Inventory Control Systems Key words: inventory control systems, continuous inventory system 6) In a periodic inventory system, a constant amount is ordered when inventory declines to a predetermined level. Answer: FALSE Diff: 2 Page Ref: 747 Main Heading: Inventory Control Systems Key words: continuous inventory system 7) The EOQ is the optimal order quantity that will minimize total carrying costs. Answer: FALSE Diff: 2 Page Ref: 748 Main Heading: The Basic EOQ Model Key words: economic order quantity models, EOQ models 8) Assumptions of the basic EOQ model include constant demand, no shortages, constant lead time, and gradual usage. Answer: FALSE Diff: 2 Page Ref: 748 Main Heading: The Basic EOQ Model Key words: economic order quantity models, EOQ models 9) The non-instantaneous receipt...

Words: 7398 - Pages: 30

Premium Essay

Mgt 496 Week 1 Quiz

...demand? Question 2. Economic order quantity (E.O.Q.) is a balance of ____________ and __________. Question 3. Which of the following statements are true about independent or random demand? Question 4. The supply chain does not need an order to operate. Question 5. Which of the following is a technique to reduce demand lead time variability (L.T.V.)? Question 6. The relationship between cost and service is always a straight line. MGT 496 WEEK 1 QUIZ To purchase this visit following link: http://www.activitymode.com/product/mgt-496-week-1-quiz/ Contact us at: SUPPORT@ACTIVITYMODE.COM MGT 496 WEEK 1 QUIZ MGT 496 Week 1 Quiz 1.Question : Which of the following is NOT an example of independent demand? Question 2. Economic order quantity (E.O.Q.) is a balance of ____________ and __________. Question 3. Which of the following statements are true about independent or random demand? Question 4. The supply chain does not need an order to operate. Question 5. Which of the following is a technique to reduce demand lead time variability (L.T.V.)? Question 6. The relationship between cost and service is always a straight line. MGT 496 WEEK 1 QUIZ To purchase this visit following link: http://www.activitymode.com/product/mgt-496-week-1-quiz/ Contact us at: SUPPORT@ACTIVITYMODE.COM MGT 496 WEEK 1 QUIZ MGT 496 Week 1 Quiz 1.Question : Which of the following is NOT an example of independent demand? Question 2. Economic order quantity (E.O.Q.) is a balance...

Words: 733 - Pages: 3

Premium Essay

Business Inventory Controls

...expensive and important assets to many companies, representing as much as 50% of total invested capital. Managers have long recognized that good inventory control is crucial” (Render et al, 2011). Therefore, it is really no surprise that companies place such a high importance on inventory control. An analysis of the planning and forecasting process, as well as the uses of inventory control will certainly verify the significance of inventory control in the business environment. In addition, by utilizing several inventory methods: economic order quantity, production run and quantity discount models, in hypothetical inventory scenarios for McDonald’s, there will be sufficient evidence to support the accuracy and importance of inventory control. Inventory Control: Planning & Forecasting The importance of inventory control and planning cannot be overstated no matter what the size of the business. Inventory control is a process managers must master in order to most effectively and efficiently deliver their company’s products or services to the customer (Render et al, 2011). The two most essential steps in effectively managing inventory are planning and forecasting. Inventory planning encompasses the “what” in terms of specific inventory stock requirements and addresses how the inventory will be acquired (Render et al, 2011). The second and arguably most important step in the inventory planning process is demand forecasting. Managers are constantly looking to reduce the risk faced...

Words: 1944 - Pages: 8

Premium Essay

Hnd Student of Hospitality and Tourism Management

...Chapter 1 1.0. Available Sources of Funding to Hospitality Industries Introduction: Hospitality industry in UK has got problems from securing funds through banks which is supposed to be reliable source of business funding. This fact has made it necessary to look beyond banks to assists with the growth of the business. HOSPACE 2013. Ben McClure, 2015 says “it is necessary that hospitality industry considers only financial funding that will not lead the business into future problems”. As if the industry does not utilize the money it borrows judiciously, it might affect its growth prospects. The actual funding sources for UK hospitality industries are hereby critically looked into; with pros and cons of the sources. 1.1 Sources of Funding available to Hospitality Industries: There are two main sources of funding which are generally available to hospitality industries especially chains of restaurants and hotels. These are the internal and external sources. The internal sources are those that can be sources through the business owner, borrowing from relatives and the retained earnings. Before embark in a business, there could be a saving by the owner to start and run the business with little or no risk. There is tendency to borrow fund from family and friends under mutual understanding whose repayment may not attract interests and with low risks. However, in case the business fails, it may tarnish the cordial relationship. It can as well leads to unnecessary interference...

Words: 4830 - Pages: 20

Premium Essay

Train

...retail stores. It buys its filters from several manufacturers. Filters are ordered in lot sizes of 1000 and each order costs $40 to place. Demand from retail stores is 20,000 filters per month, and carrying cost is $.10 a filter per month. a. What is the optimal order quantity with respect to so many lot sizes? b. What would be the optimal order quantity if the carrying cost were $.05 a filter per month? c. What would be the optimal order quantity if ordering costs were $10? 2. To reduce production start-up costs, Bodden Truck Company may manufacture longer runs of the same truck. Estimated savings from the increase in efficiency are $260,000 per year. However, inventory turnover will decrease from eight times a year to six times a year. Costs of goods sold are $48 million on annual basis. If the required rate of return on investment in inventories is 15%, should the company instigate the new production plan? 3. The Hedge Corporation manufactures only one product: planks. The single raw material used in making planks is the dint. For each plank manufactured, 12 dints are required. Assume that company manufactures 150,000 planks per year, that demand for planks is perfectly steady throughout the year, that it costs $200 each time dints are ordered, and that carrying costs are $8 per dint per year. a. Determine the economic order quantity of dints. b. What are the total inventory costs for Hedge (carrying costs plus ordering costs)? ...

Words: 273 - Pages: 2

Free Essay

Narragansett Yacht Corportation

...Taylor NyBlom FIN 340 November 10, 2014 Narragansett Yacht Corporation 1. If ordered from Supplier A, the economic ordering quantity for standard 5-inch winches is 209 units. If ordered from Supplier B, the economic ordering quantity is 148 units. 2. Assumptions of the EOQ model include sales needing to be accurately forecasted, sales needing to be evenly distributed, and orders being received on time. These assumptions appear reasonable when applied to Narragansett Yacht. 3. A. If Narragansett buys from Supplier A, 8 orders will need to be placed each year. If they buy from Supplier B, 11 orders will need to be placed each year. B. For Supplier A, the reorder point in 50 units, and for Supplier B, the reorder point is 100 units. 4. The total inventory cost for Supplier A is $14, 388, and the total inventory cost for Supplier B is $10,174. Based on the information developed so far, Narragansett should use Supplier B. Even though Supplier B has a higher reorder point and more orders will need to be placed in one year, the total inventory cost is lower. 5. A. Assuming that the desired safety stock is currently on hand and does not need to be purchased, the total cost of ordering and carrying inventories using Supplier A is $19,563. The total cost of ordering and carrying inventories using Supplier B is $20,524. B. The introduction of safety stocks increases the reorder points. For Supplier A, the reorder point would now be 125 units, and for Supplier...

Words: 569 - Pages: 3

Premium Essay

Inventory Paper

...Logistics inventory paper Inventory is the total amount of goods and/or materials contained in a store or factory at any given time. Store owners need to know the precise number of items on their shelves and storage areas in order to place orders or control losses. Factory managers need to know how many units of their products are available for customer orders. The word 'inventory' can refer to both the total amount of goods and the act of counting them. Many companies take an inventory of their supplies on a regular basis in order to avoid running out of popular items. Others take an inventory to insure the number of items ordered matches the actual number of items counted physically. Shortages or overages after an inventory can indicate a problem with theft (shrinkage) or inaccurate accounting practices. There are three basic reasons for keeping an inventory: 1. Time - The time lags present in the supply chain, from supplier to user at every stage, requires that you maintain certain amounts of inventory to use in this "lead time." 2. Uncertainty - Inventories are maintained as buffers to meet uncertainties in demand, supply and movements of goods. 3. Economies of scale - Ideal condition of "one unit at a time at a place where a user needs it, when he needs it" principle tends to incur lots of costs in terms of logistics. So bulk buying, movement and storing brings in economies of scale, thus inventory. One of the main concerns of inventory is cost, the carrying...

Words: 1630 - Pages: 7

Premium Essay

Ll Bean Case

...L.L. Bean has adopted a two stage ordering process for products with “one-shot” commitments (i.e. products that they get to order only once because of long supplier lead times). First they determine a forecast for an item and then they have a process for converting that forecast into an order quantity. Questions 1. How significant (quantitatively) of a problem is the mismatch between supply and demand for L.L. Bean? From the first page of the case we have an estimate of $11 million cost of lost sales and backorders and $10 million associated with having too much of the wrong inventory. These costs are stated as being a conservative estimate. 2. On the course website is an Excel file that contains demand and forecast data for a collection of items. Suppose those are the data L.L. Bean will use to plan their next season. Consider an item that retails for $45 dollars and costs L.L. Bean $25 dollars. The liquidation price for this item will be $15. The sales forecast for this item is 12,000. What order quantity would L.L. Bean choose for this item? Using L.L. Bean’s current methodology, our first step is to understand the frequency distribution of past forecast errors. We compute the error by dividing the actual by the forecast such that a number above 1 represents that the item was under forecasted. The plot below provides a histogram of these errors. As an example, from this plot, 50% of the errors are between 0.49 and 1.04 or 66.6% of the errors are between 0.49 and...

Words: 1177 - Pages: 5

Premium Essay

Case

...and subassemblies for a number of small-volume manufacturers of specialized construction equipment, including bulldozers, graders, and cement mixers. FabQual also manufactures and distributes spare parts. The company has made a specialty of providing spare parts for equipment no longer in production; this includes wear parts that are no longer in production for any OEM. The Materials Management Group (MMG) orders parts— both for delivery to a customer’s production line and for spares—from the Fabrication Department. Spares are stocked in a finished goods store. FabQual’s part number 650810/ss/R9/o is a wear part made only for spares demand. It has had demand averaging 300 units per week for more than a year, and this level of demand is expected to persist for at least four more years. The standard deviation of weekly demand is 50 units. The MMG has been ordering 1300 units monthly of part number 650810/ss/R9/o from the Fabrication Department to meet the forecast annual demand of 15,600 units. The order is placed in the first week of each month. In order to provide Fabrication with scheduling flexibility, as well as to help with planning raw material requirements, a three-week manufacturing lead time is allowed for parts. In the Fabrication Department, two hours is now allowed for each setup for a run of part number 650810/ss/R9/o. This time includes strip-down of the previous setup; delivery of raw materials, drawings, tools and fixtures, and the like; and buildup...

Words: 1552 - Pages: 7

Premium Essay

Homework

...1. Define a) Baumol model: is an economic model of the transactions demand for money b) Total carrying cost: the total cost of holding inventory. This includes warehousing costs such as rent, utilities and salaries, financial costs such as opportunity cost, and inventory costs related to perishability, pilferage, shrinkage and insurance Total ordering cost Total inventory costs c) Economic ordering quantity: order quantity that minimizes the total holding costs and ordering costs EOQ model: is the order quantity that minimizes the total holding costs and ordering costs. It is one of the oldest classical production scheduling models EOQ range: is the number of units that a company should add to inventory with each order to minimize the total costs of inventory d) 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: is a term used by logisticians to describe a level of extra stock that is maintained to mitigate risk of stockouts (shortfall in raw material or packaging) due to uncertainties in supply and demand e) Red-line method Two-bin method Computerized inventory control system f) Just in time system: is an inventory strategy companies employ to increase efficiency ... supply system represents a shift away from the older just-in-case strategy Outsourcing...

Words: 498 - Pages: 2

Premium Essay

Tom Cheat Sheet Midterm 1

...Dimensions of Service Quality – (Convenience, Reliability, Accuracy, Time, Responsiveness, Courtesy, Tangibles) Pull System = Demand impacts when product is produced Push System = Demand does NOT impact when product is produced Quantifying Queues – Queues are inevitable because there will always be variability, it is important how you manage them - (μ) – Service Rate - Average number of customers that a service provider can serve per unit of time - (λ) – Arrival Rate - Average number of customers arriving per unit of time - (ρ) – Utilization Rate - If arrival rate < average service rate, Utilization Rate = Arrival Rate/Service Rate (ρ = λ/ μ) - If arrival rate > average service rate, utilization is > 100% Average # of Customers in System (L) = Arrival Rate/(Service Rate – Arrival Rate) & L = λ / (μ – λ) Average # Waiting in Line (Lq) = (Utilization Rate)*(Avg. # of Customer in System) & Lq = ρ L Average Customer Time Spent in System (W) = 1 / (Service Rate – Arrival Rate) & W = 1/(μ- λ) Average Waiting Time (Wq) = Utilization Rate * Average Customer Time Spent in System & Wq = ρ W Increase in… | Output | Waiting Customers (Inv.) | Business Impact? | Service Rate | UP | DOWN | Positive | Arrival Rate | UP | UP | Trade-Off | Waiting Room Size | UP | UP | Trade-Off | Variability | DOWN | UP | Negative | # Of Servers | UP | DOWN | Positive | ------------------------------------------------- Sources...

Words: 1511 - Pages: 7

Free Essay

None

...production process do workers check bagel quality? Choosing suppliers for the ingredients or monitoring the process at each step. They could also keep equipment’s in good working conditions. c) List the steps in the production process, beginning with purchasing ingredients, and ending with the sale, and how quality can be positively affected at each step. Basic ingredients are mixed together, proper ratio of ingredients, good quality of ingredients, dough is transferred to machines, cleanliness of machines, shape of bagel should be maintained, temperature should be maintained while transportation, and time. 3. Which inventory model could be used for ordering the ingredients for bagels? The inventory model used can be: Economic order quantity (EOQ), Replenishment model. The most appropriate for deciding how many bagels to make in a given batch would be: Safety calculation or reorder point. 4. Bruegger’s has bagel-making machines at its plants. Another possibility would be to have a bagel-making machine at each store. What advantages does each alternative have? Advantage of having machine at main plant, A less investment, proper utilization of manpower, less tools required, recipe secret can...

Words: 363 - Pages: 2

Premium Essay

Reort on Littlefield

...and ascertaining what were the do’s and don’ts. The initial goal of the goal was to correlate the Re Order Point with the Customer Order Queue. To forecast Demand we used Regression analysis. We looked and analyzed the Capacity of each station and the Utilization of same. The team ascertained our job completion and our Lead Time. Our strategy throughout the stimulation was to balance our work station and reduce the bottleneck. PRIOR TO THE GAME The team consulted and decided on the name of the team that would best suit the team. With much anticipation we reviewed all the literate that was provided subsequently to assist us in decision making at Littlefield Technologies. DAY 1 (8 OCTOBER 3013) Data was extracted from “plot job arrival “and analyzed. The information was used to calculate the forecast demand using the regression analysis. The next step was to calculate the Economic Order Point (EOP) and Re Order Point (ROP) was also calculated. A discussion ensued and we decided to monitor our revenue on this day. The strategy yield a positive response as our revenue was steady at this point. DAY 2 (9 OCTOBER 2013) Based on our initial analysis we continue to monitor our progress in term of our ranking and we further calculated the forecast demand using excel. The team then proceeded to take action and we selected Contract Two (Maximum Lead Time One Day). The Re-Order point was changed to 35 batches of 60 kits to ensure...

Words: 1090 - Pages: 5

Premium Essay

Acc650 Module 3 - Week 3 Quiz Activity-Based Costing

...use a single, volume-based cost driver. assign overhead to products based on the products' relative usage of direct labor. often reveal products that were under- or over-costed by traditional costing systems. typically use fewer cost drivers than more traditional costing systems. have a tendency to distort product costs. 2. Burgoon uses an economic order quantity model and has determined an optimal order size of 500 units. Annual demand is 10,000 units, ordering costs are $50 per order, and holding costs are $4 per unit. The reorder point is: 25 packages. 50 packages. 100 packages. 203 packages. 225 packages. 1. Feinstein, Inc., an appliance manufacturer, is developing a new line of ovens that uses controlled-laser technology. The research and testing costs associated with the new ovens is said to arise from a: unit-level activity. batch-level activity. product-sustaining activity. facility-level activity. competitive-level activity. 2. Burgoon uses an economic order quantity model and has determined an optimal order size of 500 units. Annual demand is 10,000 units, ordering costs are $50 per order, and holding costs are $4 per unit. The reorder point is: 25 packages. 50 packages. 100 packages. 203 packages. 225 packages. 3. St. James, Inc., currently uses traditional costing procedures, applying $800,000 of overhead to products Beta and Zeta on the basis of direct labor hours. The company is considering a shift to activity-based...

Words: 1572 - Pages: 7