Economic Order Quantity (EOQ) and Inventory
Management
Economic Order Quantity (EOQ) is a crucial concept in inventory management. It helps businesses optimize their ordering
processes and minimize costs.
This presentation will explore EOQ fundamentals and provide practical examples.
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What is Economic Order Quantity?
1 Definition
EOQ is the optimal order quantity that minimizes total inventory holding and ordering costs.
2 Purpose
It balances the trade-off between holding costs and ordering costs.
3 Application
EOQ is widely used in manufacturing, retail, and supply chain management.
Components of EOQ Formula
Annual Demand (D)
Total quantity of items required per year.
Ordering Cost (S)
Cost incurred each time an order is placed.
Holding Cost (H)
Annual cost of storing one unit of inventory.
EOQ Formula
The Formula
EOQ = √((2DS)/H)
Interpretation
The square root of (2 times annual demand times ordering cost) divided by holding cost.
Assumptions
Constant demand, fixed costs, and instantaneous replenishment.
Example 1: Retail Store
Scenario
A clothing store needs to
determine its EOQ for t-shirts.
Given Data
Annual demand: 10,000 units. Ordering cost: $50.
Holding cost: $2 per unit per year.
Calculation
EOQ = √((2 * 10,000 * 50) / 2) = 707 units
Example 2:
Manufacturing Plant
Annual Demand (D) 5,000 units
Ordering Cost (S) $100
Holding Cost (H) $4 per unit per year
EOQ Calculation √((2 * 5,000 * 100) / 4)
= 500 units
Example 3: Restaurant Supply
1 Step 1: Gather Data
Annual demand: 2,400 kg of rice. Ordering cost:
$30. Holding cost: $0.5 per kg per year.
2 Step 2: Apply Formula
EOQ = √((2 * 2,400 * 30) / 0.5) = 534 kg
3 Step 3: Interpret Results
The restaurant should order 534 kg of rice per order to minimize costs.
Example 4: Pharmaceutical Company
Input Data
Annual demand: 8,000 units. Ordering cost: $75. Holding cost: $3 per unit per year.
Calculate EOQ
EOQ = √((2 * 8,000 * 75) / 3) = 632 units
Implement
Order 632 units of medication per order to optimize inventory costs.
Example 5: Auto Parts Distributor
Inventory Management
An auto parts distributor needs to optimize its inventory of
brake pads.
Product Focus
Annual demand: 15,000 units.
Ordering cost: $40. Holding cost: $1.5 per unit per year.
EOQ Calculation
EOQ = √((2 * 15,000 * 40) / 1.5) = 894 units per order
Benefits of Using EOQ
1 Cost Reduction
Minimizes total inventory costs by balancing ordering and holding expenses.
2 Improved Efficiency
Streamlines ordering processes and reduces stockouts.
3 Better Cash Flow
Optimizes inventory investment and frees up working capital.
4 Data-Driven Decisions
Provides a quantitative basis for inventory management decisions.
Limitations of EOQ Model
Constant Demand Assumption
Real-world demand often fluctuates, affecting EOQ accuracy.
Fixed Costs
Ordering and holding costs may vary over time or with order size.
Instantaneous Replenishment
Lead times are not
considered in the basic EOQ model.
Conclusion: EOQ in Practice
Adaptability
Use EOQ as a starting point and adjust for real- world complexities.
Regular Review
Periodically reassess EOQ calculations as business conditions change.
Integration
Combine EOQ with other inventory
management techniques for best results.
Technology
Leverage software tools to automate EOQ calculations and inventory tracking.
