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EOQ,Economic Order Quantity

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The Economic Order Quantity (EOQ) is a formula used to determine the optimal quantity of inventory to order at one time, considering factors such as the cost of order placement, the cost of carrying inventory, and the cost of stockouts.

Formula:

EOQ = sqrt(2DS / H)

where:

  • EOQ is the economic order quantity
  • D is the daily demand
  • S is the cost of placing an order
  • H is the cost of carrying inventory per unit

Explanation:

  • The formula calculates the square root of the ratio of twice the daily demand (D) times the cost of placing an order (S) to the cost of carrying inventory (H).
  • The EOQ is the quantity that minimizes the total cost of inventory management, which includes the cost of order placement, the cost of carrying inventory, and the cost of stockouts.
  • The EOQ is a variable that is used in inventory management to determine the optimal order quantity for a given set of circumstances.

Advantages:

  • Optimizes inventory levels, reducing carrying costs and stockouts.
  • Reduces order placement costs.
  • Increases inventory turnover.

Disadvantages:

  • Can be complex to calculate, especially for small quantities.
  • May not be suitable for items with fluctuating demand or high order costs.
  • Can lead to stockouts if demand exceeds the EOQ.

Example:

For a company that sells 100 units per day, has an order placement cost of $50, and carries inventory costs of $10 per unit, the EOQ would be:

EOQ = sqrt(2(100) * 50 / 10) = 10 units

Therefore, the optimal order quantity is 10 units.

Note:

The EOQ formula is an approximation and should be used as a guide, not as an exact solution. Factors such as lead time, product perishability, and demand variability can also affect the EOQ.

FAQs

  1. What is the Economic Order Quantity (EOQ)?

    Economic Order Quantity (EOQ) is a formula used in inventory management to determine the optimal order quantity that minimizes the total cost of inventory, including ordering and holding costs. It helps businesses decide the most cost-effective quantity of stock to order at one time to reduce overall inventory expenses.

  2. What is the carrying cost in the EOQ formula?

    Carrying cost, also known as holding cost, refers to the expenses incurred for storing inventory over a period. In the EOQ formula, carrying cost (H) includes costs like storage, insurance, depreciation, and opportunity costs. It is typically expressed as a percentage of the inventory value per unit per year.

  3. What is the meaning of order quantity?

    Order quantity refers to the amount of stock or inventory ordered at one time by a business. It is a key component in inventory management and can impact the balance between inventory carrying costs and ordering costs. The optimal order quantity helps to minimize these combined costs while ensuring that inventory levels meet customer demand.

  4. What does the EOQ formula assume?

    The EOQ formula assumes that demand for the product is constant throughout the year, ordering costs and holding costs remain constant, lead time is fixed, there are no stockouts, and the entire order quantity is received at once.

Disclaimer

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