ACC2232 - Economic Order Quantity (EOQ)

What is EOQ?

 

EOQ is the acronym for economic order quantity. The economic order quantity is the optimum quantity of goods to be purchased at one time in order to minimize the annual total costs of ordering and carrying or holding items in inventory.EOQ is also referred to as the optimum lot size.

 

The formula to calculate the economic order quantity is the square root of [(2 times the annual demand in units times the incremental cost to process an order) divided by (the incremental annual cost per unit to carry an item in inventory)].

 

HOLDING COST

•  Interest on fund borrowed
•  Storage charges (rent)
•  Insurance and security
•  Cost of obsolescence of stocks

ORDERING COST

•  Clerical costs preparing purchase order and transportation

ORDERING COST

•  Cost without having stock
•  Loss of contribution
•  Loss of customer future sale/goodwill
•  Production stoppage

 

Let's try this!

 

Annual demand quantity : 1500 units

Ordering cost: RM30 per order

Cost per unit of item: RM5

Holding cost: 20% of inventory cost

 

Calculate the EOQ.

 

Another one...

 

Nadzmi runs a mail-order business for gym equipment. Annual demand for the AbsFlexer is 16,000. The annual holding cost per unit is $2.50 and the cost to place an order is $50. What is the economic order quantity?

 

However, the EOQ implementation has to be based on the following assumptions....

 

Assumptions:

• Demand is constant
• Holding and ordering cost are constant
• Unit price is constant
• Quick delivery
• Replenishment is made instantaneously (the whole batch is delivered at once)