Lesson 1, Topic 1
In Progress

2.3. An Economic Ordering Quantity Model (EOQ) model is explained and applied to a business unit to calculate the optimum stock level for three items in a business unit.

ryanrori January 14, 2021

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Economic order quantity (EOQ)

We could buy-in, or make for stock either a few large orders or frequent small orders for a given usage. Few big orders involve low acquisition and high holding costs. Conversely many small orders result in low holding and high acquisition costs. Purchasing an economic order quantity (a.k.a. economic batch quantity, economic lot size or EOQ) seeks to reconcile ordering and holding costs to obtain an optimum order size.

Cost of holding stock and ordering/acquisition cost are represented by the formulae

  • The value of the average stockholding = (Q/2 x item cost/value) where Q is the order quantity. The holding cost/unit (Ch) is derived from the average inventory value) multiplied by the cost of carrying the item over the period (one year) expressed as a % of the item cost/value.
  • Order cost (Co) is derived from the number of orders placed (D/Q – demand p.a. divided by order quantity) multiplied by the cost of placing an order.

The order/acquisition cost (or set-up cost for a make-to-stock situation).

Therefore Total cost = Ch + Co

These relationships can be seen in the graphic representation of EOQ.

EOQ Evaluation and Assumptions of simple EOQ

  • demand (units of supply, not issue) is known and steady so average inventory can be estimated
  • quantity discounts do not apply – the effect of buying discount/price breaks needs to be calculated additionally.