Economic Order Quantity

Bus M361-2
Sabrina Wu
11/28/2005
 Economic Order Quantity
Definition of EOQ
How to use the EOQ model in a
business organization
How the EOQ model works
Real world example
 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.
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.
 How EOQ Works
The Principles Behind EOQ: The Total Cost Curve

& 
 How EOQ Works
The Principles Behind EOQ: The Holding Costs

Keeping inventory on hand

Interest
Insurance
Taxes
Theft
Obsolescence
Storage Costs
 How EOQ Works
The Principles Behind EOQ: The Holding Costs

Interest

Obsolescence

Storage
 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
 How EOQ Works
The Total Cost Formula

Total Cost = Purchase Cost + Order Cost + Holding Cost

 How EOQ Works
The Total Cost Formula

This represents the

unchanging fixed costs

P = Purchase cost per unit

R = Forecasted monthly usage
 How EOQ Works
The Total Cost Formula

This represents the

variable order costs
P = Purchase cost per unit
R = Forecasted monthly usage
C = Cost per order event (not per unit)
Q = The number of units ordered
 How EOQ Works
The Total Cost Formula

This represents the

variable holding costs
P = Purchase cost per unit
R = Forecasted monthly usage
C = Cost per order event (not per unit)
Q = The number of units ordered
F = Holding cost factor
 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:
 How EOQ Works
The EOQ Formula

The result of differentiation

The Economic Order Quantity

 How EOQ Works
The EOQ Formula

Review and Summary of the EOQ Formula

P = Purchase cost per unit

R = Forecasted monthly usage
C = Cost per order event (not per unit)
F = Holding cost factor
 How EOQ Works
The EOQ Formula

Review and Summary of the EOQ Formula

Here is the a graphic representation of the EOQ equation

Real Life Example:
Real Life Example:
 Real Life Example:

First, Recall the

EOQ Equation:

P = Purchase cost per unit

R = Forecasted monthly usage
C = Cost per order event (not per unit)
F = Holding cost factor
 Real Life Example:

Next let’s identify the

correct variables…
 Real Life Example:

Next let’s identify the

correct variables…
Forecasted
Amount
 Real Life Example:

Next let’s identify the

correct variables…

Ordering
Costs
 Real Life Example:

Next let’s identify the

correct variables…

Cost per
Unit
 Real Life Example:

Next let’s identify the

correct variables…

Holding
Cost Factor
 Real Life Example:

R = Annual demand
C = Fixed ordering cost
P = Cost per case
F = Holding Cost Factor
 Real Life Example:

R = 5200
C = $10 per order
P = $2
F = 20% of value of
inventory per year
 Real Life Example:

R = 5200
2(10) (5200)
C = $10 per order EOQ =
(2 )(.20)
P = $2
F = 20% of value of
inventory per year
 Real Life Example:

2(10) (5200)
EOQ =
(2 )(.20)

EOQ = 510 cases

 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.
 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
 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