Q. What is E.O.Q.? Explain in detail with appropriate example?

E.O.Q. is a deterministic type of inventory model. The object of inventory

control is to avoid the situation of over as well as under investment. The level of
inventories should be maintained at the optimum level deterministic inventory model
assumes that the note of demand for the item is constant as nearly constant.
The E .O. Q Model is applicable when the demand for on item has a constant as
nearly constant note and when the entire quantity ordered arrives in inventory at one
point af time (instantaneously).
E. O. Q indicates that quantity, which is fixed in such a way that the total variable
lost of managing the inventory, can be minimized. Such cost basically consists of two
parts :-
First , Ordering cost and second, Carrying cost. There is a reverse relationship
between these two types of costs i.e. If the purchase quantity increases, ordering cost
may get reduced but the carrying cost increases and vice versa. A balance is to be
struck between these two factors and it is possible at Economic order Quantity where
the total variable cost of managing the inventory is minimum.
The E.O.Q. model system is also known as fixed – order quantity system (Q
system) or a continuous or perpetual review system. In this system is placed for the
some constant or fixed amount known as economic order quantity) whenever the
inventory level or reorder point. Continual record of inventory level for every item is
maintained. The order that is placed to replenish the stock of inventory is for a fixed
quantity, which minimizes the total inventory carrying, ordering and storage costs.
A positive feature of a continuous review system is that inventory level is
closely and continuously monitored so that management always knows the inventory
status. This is advantageous for critical items such as replacement parts of raw
materials or supplies.
The function of the EOQ model, also referred to as the economic lot size model
is to determine the optimal size that minimizes total inventory costs.
There are several variations of the E.O.Q. mode, depending upon the
assumptions made about the inventory system. There such variations are :-
a) The basic E.O.Q. Model (Instantaneous Supply)
b) The E.O.Q. model with non-instantaneous receipt or gradual arrival of
supplies
c) The E.O.Q. model with shortages.
THE BASIC EOQ MODEL
The formula for E.O.Q. and re-order level are derived under a set of simplifying
and restrictive assumptions as follows :-
 Demand is known with certainty and is relatively constant over time.
 No shortages are allowed.
 Load time for the receipt of orders is constant.
 The order quantity is received all at once i.e. instantaneously.
The following figure illustrates these basic model assumptions:-

BASIC INVENTORY MODEL

The above diagram describes the continuous inventory order cycle
system inherent in the E.O.Q. model. An order quantity ‘Q’ is received and is
used up over time at a constant rate. When the inventory level decreases to the
re-order point “R” a new order is placed and period of time relearned to as the
lead-time, is required for delivery. The order is received all at once just at the
moment when demand has used up the entire stock of inventory, thus allowing
no shortages. This
Cycle is continuously repeated for the same order quantity re-order point and
lead-time.
 Assumptions Used In the Basic E.O.Q. Model:-

1) Only one product is involved.

2) Annual demand requirements are known.
3) Demand is spread evenly throughout the year.
4) Demand rate for the item is constant and known with certainty
5) No constraints on the size of each lot.
6) Only two relevant casts are the inventory carrying cost and the ordering cast.
7) No uncertainty in lead-time or supply. The lead times are constant and know
with certainty.
8) Each order is received in a single delivery.
9) Quantity received is exactly what was ordered and it arrives at once.
10)There are no quantity discounts.

DERIVATION OF E.O.Q. FORMULA:-

 It is possible to fix the Economic Order Quantity with the help of Mathematical
formula. The following assumptions may be made for this purpose.

Let, Q be Economic order Quantity

A be Annual Requirement of Material in units.
O be Cost of placing on order
C be Cost of carrying one unit per Year.

Now if A is the annual requirement and Q is the size of one order, the total no
of orders will be A/Q and the total ordering cast will be – A/Q ×O.
Similarly if the size of one order is Q and if it is assumed that the inventory is
reduced at a constant rate from order quantity to zero when it is repurchased, the
average inventory will be Q/2, and the Cost of carrying cost will be Q/2 × C

Thus, Total Cost = Ordering Cost + Carrying cost

= A×O+ Q×C
Q 2
The intention is that the value of Q should be such that the total cost should be
minimum Hence, taking the first derivative of the equation with respect to Q and
setting the result to Zero. do = AO { -1 } + c =0
de {Q2 } 2

Where ,
Q = Economic Order Quantity
A = Annual Requirement in units
O = Cost of placing an Order
C = Cost of carrying one unit per year.
The Manager use of the E. O. Q Model: -
The E O Q Model results in a recommended order quantity . But this
quantity need not be the final decision of the manager. He may have to exercise
his judgment into establishing the final inventory policy regarding how much to
order and when to order. The decision maker may have to modify the final order
quantity and re-order level recommendation to meet the unique circumstances of
the inventory situation. Several alternatives may arise such as :-

a) Ordering a quantity more than E.O.Q. if the vendor offers a lesser unit price
for higher order quantities.

b) Ordering a quantity, which will result in whole number of orders per year,
even though their order quantity is slightly more or less than E.O.Q.

c) Ordering a quantity deviating from E.O.Q. to facilitate cheaper

transportation cost.

d) Ordering a quantity other than E.O.Q. which may be stipulated by the

vendor as the minimum order quantity which he may accept to supply.

Also, the inventory control manger may have to recognize the fact that
E.O.Q. model is based on the constant demand rate assumption whereas,
in reality, the demand rate may fluctuate from time to time. Also the recorder
level is so fixed that the E.O.Q. order when arrives, the inventory level
reaches zero level. This assumes that the lead-time assumed would be
exactly net by the supplier, which may not be the case in reality. The
estimation of lead-time exactly becomes critical to protect against
shortages. Hence, to protect against shortages, due to higher than expected
demand or slightly delayed incoming orders, the inventory control manager
may have to increase the re-order level by sense amount. This quantity by
which the recorder level exceeds the expected lead- time demand is
referred to as safety stock.
  Limitations of E.O.Q.:
E.O.Q. technique in determining quantity per order, suffers from
following limitations:-

1) Often the inventory holding cost and the ordering cost cannot
be identified properly.

2) E.O.Q. in calculation, may come out as an inconvenient

number.

3) The use of E.O.Q. may lead to orders at random point of time,

which would result in vendor receiving irregular stream of orders.

4) E.O.Q. applied without considering the possibility of falling

demand is future, can lead to high value of obsolescent inventory.

5) E.O.Q. may not be applicable when the requirements are

irregular are where there is likely price rise.