AbstractEconomic order quantity is the level of inventory that minimizes total inventory holding costs and ordering costs.

It is one of the oldest classical production scheduling models. The framework used to determine this order quantity is also known as Wilson EOQ Model or Wilson Formula. The model was developed by Ford W. Harris in 1913. EOQ applies only when demand for a product is constant over the year and each new order is delivered in full when inventory reaches zero. There is a fixed cost for each order placed, regardless of the number of units ordered. There is also a cost for each unit held in storage, sometimes expressed as a percentage of the purchase cost of the item. We want to determine the optimal number of units to order so that we minimize the total cost associated with the purchase, delivery and storage of the product.

The required parameters to the solution are the total demand for the year, the purchase cost for each item, the fixed cost to place the order and the storage cost for each item per year. Note that the number of times an order is placed will also affect the total cost, though this number can be determined from the other parameters.

 Economic

Order Quantity

Definition of EOQ Assumption How to use the EOQ model in a business organization How the EOQ model works Real world example

EOQ or Economic Order Quantity, is defined as the optimal quantity of orders that minimizes total variable costs required to order and hold inventory.

The ordering cost is constant. The rate of demand is known, and spread evenly throughout the year. The lead time is fixed. The purchase price of the item is constant i.e. no discount is available The replenishment is made instantaneously, the whole batch is delivered at once. Only one product is involved. EOQ is the quantity to order, so that ordering cost + carrying cost finds its minimum. (A common misunderstanding is that the formula tries to find when these are equal.)

 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.

Q
Quantity on hand

Usage rate

Profile of Inventory Level Over Time

Reorder point

Receive order

Place Receive order order

Place Receive order order

Time

LEAD TIME

Keeping inventory on hand Interest Insurance Taxes Theft Obsolescence

How EOQ Works

The Principles Behind EOQ:Holding costs

Interest

Obsolescence

Storage

The Principles Behind EOQ: The Holding Costs

How EOQ Works

Primarily the labor costs associated with processing the order:

Ordering A portion of the freight if the amounts vary according to the size of the order

Receiving, inspecting, stocking

How EOQ Works

The Principles Behind EOQ:Procurement costs

Total Cost = Purchase Cost + Order Cost + Holding Cost

This represents the unchanging fixed costs

P = Purchase cost per unit R = Forecasted monthly usage

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

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

Taking the derivative of both sides of the equation and setting equal to zero to find the minimum value of the function, one obtains.

The result of differentiation

The Economic Order Quantity

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