Economic Order Quantity Flashcards, test questions and answers

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What is Economic Order Quantity?

The Economic Order Quantity (EOQ) is an inventory control model used to determine the most cost-efficient order quantity of a product. It is based on the idea that ordering costs increase with larger orders and carrying costs increase with larger inventories. The EOQ balances these costs to find an optimal order quantity that minimizes overall ordering and carrying costs. The EOQ formula takes into account the cost of ordering, the cost of holding, the demand rate, and lead time in order to calculate the optimal reorder point. The formula used for calculating EOQ involves two basic steps: firstly, estimating the total annual cost by taking into account both ordering and holding costs; secondly, determining how often orders should be placed in a year to minimize total annual inventory cost. The main components of calculating EOQ are: demand rate (D), setup or ordering cost (S), carrying or holding cost per item per year (H) and lead time (L). To calculate EOQ one must divide two factors: S multiplied by D divided by H multiplied by L. This will give a result which is equivalent to how many items should be ordered at once in order to minimize total inventory costs each year while still meeting customer demand. For example, if a company has $50 setup or ordering costs each time they place an order for their product, $2 holding or carrying costs per item per year and they expect 10 units of their product sold every month with 1 month lead time then their EOQ would be 100 units: ($50 * 10)/($2 * 1). This means that this company should place orders for 100 units at a time in order to achieve balance between setup/ordering expenses and carrying/holding expenses as well as meeting customer needs in terms of delivery timescales. Using calculations based on EOQ principles can help companies make better decisions when it comes to deciding how much inventory they should have on hand at any given moment so that they can save money while still having enough stock available when customers need it. Companies can use this information to adjust purchasing strategies accordingly in order to get maximum benefit from using economic order quantities.