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Economic Order Quantity
Bus M361-2
Sabrina Wu
11/28/2005
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Economic Order QuantityDefinition of EOQHow to use the EOQ model in a
business organizationHow the EOQ model worksReal world example
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The Definition of EOQ
EOQ, or Economic Order Quantity, is defined as the optimal quantity of orders that minimizes total variable costs required to order and hold inventory.
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How to use EOQ in your organization
How much inventory should we order each month?
The EOQ tool can be used to model the amount of inventory that we should order each month.
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How EOQ Works
&
The Principles Behind EOQ: The Total Cost Curve
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How EOQ Works
The Principles Behind EOQ: The Holding Costs
Keeping inventory on hand
Interest
Insurance
Taxes
Theft
Obsolescence
Storage Costs
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How EOQ Works
The Principles Behind EOQ: The Holding Costs
Interest
Obsolescence
Storage
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How EOQ Works
The Principles Behind EOQ: The Procurement Costs
Primarily the labor costs associated with processing the order:
Ordering and requisition
A portion of the freight if the amounts vary according to the size of the order
Receiving, inspecting, stocking
Invoice processing
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How EOQ Works
The Total Cost Formula
Total Cost = Purchase Cost + Order Cost + Holding Cost
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How EOQ Works
The Total Cost Formula
This represents the unchanging fixed costs
P = Purchase cost per unitR = Forecasted monthly usage
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How EOQ Works
The Total Cost Formula
This represents the variable order costs
P = Purchase cost per unitR = Forecasted monthly usageC = Cost per order event (not per unit)Q = The number of units ordered
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How EOQ Works
The Total Cost Formula
This represents the variable holding costs
P = Purchase cost per unitR = Forecasted monthly usageC = Cost per order event (not per unit)Q = The number of units orderedF = Holding cost factor
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How EOQ Works
The EOQ Formula
Total Cost Formula
Taking the derivative of both sides of the equation and setting equal to zero to find the minimum value of the function, one obtains:
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The result of differentiation
How EOQ Works
The EOQ Formula
The Economic Order Quantity
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How EOQ Works
The EOQ Formula
Review and Summary of the EOQ Formula
P = Purchase cost per unitR = Forecasted monthly usageC = Cost per order event (not per unit)F = Holding cost factor
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How EOQ Works
The EOQ Formula
Review and Summary of the EOQ Formula
Here is the a graphic representation of the EOQ equation
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Real Life Example:
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Real Life Example:
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Real Life Example:
First, Recall the EOQ Equation:
P = Purchase cost per unitR = Forecasted monthly usageC = Cost per order event (not per unit)F = Holding cost factor
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Real Life Example:
Next let’s identify the correct variables…
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Real Life Example:
Next let’s identify the correct variables…
Forecasted Amount
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Real Life Example:
Next let’s identify the correct variables…
Ordering Costs
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Real Life Example:
Next let’s identify the correct variables…
Cost per Unit
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Real Life Example:
Next let’s identify the correct variables…
Holding Cost Factor
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Real Life Example:
R = Annual demand
C = Fixed ordering cost
P = Cost per case
F = Holding Cost Factor
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Real Life Example:
R = 5200
C = $10 per order
P = $2
F = 20% of value of inventory per year
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Real Life Example:
R = 5200
C = $10 per order
P = $2
F = 20% of value of inventory per year
EOQ = 2(10) (5200)
(2 )(.20)
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Real Life Example:
EOQ = 2(10) (5200)
(2 )(.20)
EOQ = 510 cases
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Wrapping It Up EOQ, or Economic Order Quantity, is defined as the optimal quantity of orders that minimizes total variable costs required to order and hold inventory.
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Closing Comments
EOQ is a tool, not a simple solution.
EOQ is useful in determining optimal order quantity
Understand the equation and what you are trying to find
Find accurate inputs for the equation
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Additional Resources on EOQ• http://www.findarticles.com/p/articles/mi_m0KAA/is_5_31/
ai_94771293
• http://www.inventoryops.com/economic_order_quantity.htm
• http://en.wikipedia.org/wiki/Economic_order_quantity