Economic order quantity

 

Economic order quantity is an optimal order quantity that minimizes the total inventory cost for instance holding cost and ordering cost. In inventory management economic order quantity that minimizes the total holding cost and ordering cost. It is the one of the old classical production scheduling models. The model was developed by Ford .W. Harris in 1913 but R .H. Wilson a consultant who applied it extensively and R. Andler are given credit for their depth analysis,

 

Examples of using EOQ

EOQ is determined as follows   EOQ =

                                                         Where, d = annual demand

                                                                       C = ordering cost per order

                                                                       h = holding cost per item per annum

 

For example

A factory requires 1,5oo units of an item per month. The cost of each unit is Tsh 2,700. The cost per order is Tsh.15,000 and material carrying cost is 20% of the price per item per annum.

Required: Calculate the EOQ

 Solution: Q=

Workings:  d= 15,000 x 12 = 18,000 units

 

                     =

 

                     = 1000 units

EOQ takes into account the timing of re-ordering, the cost incurred to plce an order and costs to store merchandise. If the company is constantly placing small orders to maintain a specific inventory level, the ordering cost are higher, along with the need for additional storage space. Assume for example a retail clothing shop carries a line of min jeans and the shop shells 1,000 pairs of jeans each year. It costs the company $ 5 per year to hold a pair of jeans in inventory and the fixed cost to place an order is $ 2. Therefore the EOQ formula is the square root of (2x1000 pair x $2 order cost) / ( $5 holding cost) or 28.3 with rounding. The ideal order size to minimize costs and meet customer demand slightly more than more than 28 pairs of jeans. A more complex portion of the EOQ formula provides the re-order point.

 

The following are the roles of economic order quantity in the process of minimizing inventory cost,

 

Minimizes storage and holding costs, inventory may be expensive for small business owners. The main advantage of the EOQ model is the customized recommendations provided regarding the most economical number of units per orders. The model may suggest buying a larger quantity in fewer orders to take advantage of discount bulk buying and minimizing order cost. Alternatively, it may point to more orders of fewer items to minimize holding costs if they are high and ordering costs are relatively low.

Specific to the business, maintaining sufficient inventory levels to match customer demand is a balancing act for many small businesses. Another advantage of the EOQ model is that it provides specific numbers particular to the business regarding how much inventory to hold, when to re-order it and how many items to order, This smooth out the restocking process and results in better customer services as inventory is available when needed.

The EOQ formula can be used to calculate a re-order point which is a level of inventory that triggers the need to place an order for more inventory. By determining a re-order point. The business avoids running out of inventory and is able to fill all customer orders. If the company runs out of inventory, there is a shortage cost which is the revenue cost, because the company does not fill an order. Having an inventory shortage may also mean the company loses the customer or the client orders less in the future.

         Economic order quantity is an important tool for management to minimize the cost of inventory and the amount of cash tied up in the inventory balance. For many companies, inventoryis the largest asset owned by the company and these business must carry sufficient inventory to meet the needs of customers. If EOQ can help to minimize the level of inventory the cash savings can be used for some other business purpose investment.

 

 

Generally, Economic order quantity is an important tool in reducing inventory cost. Although it has advantage in reducing cost Economic order quantity have challenges such as involving complicated math calculations, it requires good understanding of algebra also, Economic order quantity based on assumptions for instance it assumes steady demand of a business product and immediate availability of items to be re-stocked.

 

 

 

 

 

 

 

 

 

References;

 

1. Hax, AC; Candea, D. (1984), production and operation management, Englewood Cliffs, NJ; prentice-Hall P,135.

2. North Carolina State University; Economic order quantity MODEL- Inventory management models: A Tutorial.

3. Inc; Economic order quantity (EOQ).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comments

Popular posts from this blog

International Law

KATIBA YA KIKUNDI