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## Economic Order Quantity

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**Economic Order Quantity**Bus M361-2 Sabrina Wu 11/28/2005**Economic Order Quantity**EOQ • 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:**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 C = $10 per order P = $2 F = 20% of value of inventory per year 2 (10) (5200) EOQ = (2 )(.20)**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