What is Economics Order Quantity (EOQ)?
This is the re-order quantity where the total relevant cost of inventory is minimized. EOQ is also known as optimal re-order quantity. It also the ordering quantity at which the control cost ordering is minimized. See also, Inventory Control Summary.
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Assumptions of EOQ.
(1) There is no lead time
(2) There is no quantity discount
(3) The rate of demand is known
(4) There will be no opening and closing stock
(5) The holding and ordering cost are controllable
Derivation of the EOQ Model.
Let:
- D – Annual Demand
- Co – Ordering Cost Per Order
- H – Holding Cost Per Unit
- Q – Re-order Quantity
- P – Purchase Cost Per Unit
Formula Derivation:
- Annual demand = D divided by Q
- Total ordering cost = D divided by Q x Co
- Average cost = Q divided by 2
- Total holding cost = Q divided by 2 x H
- Total inventory cost (controllable) = D x Co divided by Q + Q x H divided by 2
- Total inventory cost (uncontrollable) = PD + D x Co divided by Q + Q x H divided by 2
Monetary control of material
This is the control of the monetary values of materials in order to minimize cost or capital outlay.
It involves the control of the operating cost of the materials in stock.
Types of costs
- Purchase cost.
- Carrying / Holding / Storage cost.
- Ordering cost.
- Stock-out cost.
Definition of the Terms Above
- Purchase Cost: This is the cost of obtaining suppliers as raw material.
- Carrying / Holding / Storage cost: Cost of keeping the raw materials in your store.
- Ordering Cost: Cost of placing an order or orders for raw materials, which also includes delivery cost.
- Stock-out Cost: This cost is incurred when you don’t have any goods to sell.
Video Guide on EOQ
This video will help you understand how to derive the formulas for EOQ (Economic Order Quantity). Click here to watch on YouTube or watch the same video below.