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ECONOMIC ORDER QUANTITY

What is Economic Order Quantity?

Home | What is Economic Order Quantity? | Its Cost Components | EOQ Model with Purchases | Assumptions of the Model | Optimizing Economic Order Quantity | Graphical Solutions | Sample Problems | Answers

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What is Economic Order Quantity?

    Inventory is held to avoid the nuisance, the time and the cost etc. of constant replenishment. However, to replenish inventory only infrequently would necessitate the holding of very large inventories. It is therefore apparent that some balance or trade-off or compromise is needed in deciding how much inventory to hold, and therefore how much inventory to order. There are costs of holding inventory and there are costs of re-ordering inventory and these two costs need to be balanced. The purpose of the EOQ model is to minimize the total costs of inventory. 

    The important costs are the ordering cost, the cost of placing an order, and the cost of carrying or holding a unit of inventory in stock. All other costs such as, for example, the purchase cost of the inventory itself, are constant and therefore not relevant to the model.

*         A model that can be used to determine the quantity of an item to be ordered or manufactured that minimizes total acquisition and inventory carrying costs. Although the EOQ concept can be used in a variety of applications, its most common use today is for independent demand items managed in an order-point inventory management system.

*         The amount of orders that minimizes total variable costs required to order and hold inventory.

*                                                                                                                                                                                         Is the optimum number of stock per order that will reduce inventory costs to a minimum.  The spreadsheet demonstrates and calculates economic order quantity for a given stock item as well as the annual inventory cost.

*                                                                                                                                                                                                                                                                                        The optimum quantity of each product that must be ordered to balance the inventory holding costs against the order processing costs; holding costs increase with more inventory, while order processing costs decrease.                                                                                                                                                                                                                                                                                                                                                                       

*         As it is known in purchasing, is the amount at which the combination of order costs and inventory carrying costs is minimized. It is the most cost effective quantity to order. The EOQ model is applicable if demand for an item has a constant rate and the entire quantity ordered arrives in inventory at one point in time.

*         Balances the cost acquisition and the cost of carrying material to minimize total costs. Use EOQ after any pricing anomalies found have been explained. The worksheet has been designed to permit you to perform sensitivity analyses (comparing the total cost based for different price/volume relationships).

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