Calculation of Economic Order Quantity (EOQ)

What is Economic Order Quantity (EOQ)?

- EOQ is the amount of inventory that minimizes the total cost of inventory management.

Formula for EOQ Calculation:

- EOQ = √[(2 × D × S) ÷ H]
- Where,
- D = Annual Demand
- S = Setup or Ordering Cost per Order
- H = Holding or Carrying Cost per Unit per Year

Calculation of EOQ for the Given Scenario:

- D = Annual Demand = 10,000 units
- S = Setup or Ordering Cost per Order = $150
- H = Holding or Carrying Cost per Unit per Year = $5

- EOQ = √[(2 × D × S) ÷ H]
- EOQ = √[(2 × 10,000 × $150) ÷ $5]
- EOQ = √[(3,000,000) ÷ $5]
- EOQ = √[600,000]
- EOQ = 774.6 units (approx.)

- Therefore, the EOQ for the given scenario is 774.6 units (approx.).

Explanation of EOQ Calculation:

- The EOQ calculation is based on the trade-off between the ordering cost and the carrying cost of inventory.
- The ordering cost is the cost of placing an order, which includes the cost of preparing and processing the order, and the cost of transportation and delivery.
- The carrying cost is the cost of holding inventory, which includes the cost of storage, insurance, obsolescence, and spoilage.
- The EOQ formula determines the optimal quantity of inventory to order at one time that minimizes the total cost of inventory management.
- The formula considers the annual demand, the setup or ordering cost per order, and the holding or carrying cost per unit per year.
- The EOQ calculation assumes that the demand is constant and known, the lead time is fixed and consistent, and the ordering cost and the carrying cost are independent of the order quantity.
- The EOQ calculation provides a useful guideline for inventory management, but it may not be accurate in practice due to variability and uncertainty in demand, lead time, and cost. Therefore, it is important to monitor and revise the EOQ periodically based on actual performance and feedback.