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Economic Order Quantity (EOQ) - Material Cost, Cost Accounting Video Lecture | Cost Accounting - B Com
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FAQs on Economic Order Quantity (EOQ) - Material Cost, Cost Accounting Video Lecture - Cost Accounting - B Com
| 1. What is Economic Order Quantity (EOQ) and how is it calculated? |  |
Ans. Economic Order Quantity (EOQ) is a formula used in inventory management to determine the optimal order quantity that minimizes the total cost of holding and ordering inventory. It helps businesses find the balance between carrying too much inventory (which incurs holding costs) and ordering too frequently (which incurs ordering costs).
The formula to calculate EOQ is: EOQ = √(2DS/H), where D represents annual demand, S represents ordering cost per order, and H represents holding cost per unit per year.
| 2. What are the advantages of using Economic Order Quantity (EOQ) in inventory management? | |
Ans. There are several advantages of using EOQ in inventory management:
1. Cost reduction: EOQ helps in minimizing both holding costs and ordering costs, leading to overall cost reduction in inventory management.
2. Optimal inventory levels: EOQ ensures that the right amount of inventory is ordered at the right time, preventing stockouts and excess inventory.
3. Increased efficiency: By using EOQ, businesses can streamline their inventory management processes and reduce the need for frequent manual calculations.
4. Better cash flow management: EOQ helps in optimizing the cash flow by reducing the tied-up capital in excess inventory.
5. Improved customer satisfaction: With optimal inventory levels, businesses can fulfill customer orders promptly, leading to higher customer satisfaction.
| 3. How does Economic Order Quantity (EOQ) impact material cost? | |
Ans. Economic Order Quantity (EOQ) can impact material costs in the following ways:
1. Reducing holding costs: EOQ helps in minimizing holding costs by ordering the optimal quantity of materials. Holding costs include expenses such as warehousing, insurance, and depreciation.
2. Reducing ordering costs: EOQ also helps in reducing ordering costs by determining the optimal order quantity. Ordering costs include expenses such as purchase order processing, transportation, and inspection.
3. Balancing stockouts and excess inventory: EOQ helps in finding the right balance between stockouts (which can result in lost sales and dissatisfied customers) and excess inventory (which incurs holding costs). By maintaining optimal inventory levels, businesses can minimize both stockouts and excess inventory, thus reducing material costs.
4. Improved supply chain management: With EOQ, businesses can optimize their supply chain by ensuring timely delivery of materials, avoiding rush orders, and minimizing disruptions in production.
| 4. How does Economic Order Quantity (EOQ) relate to cost accounting? | |
Ans. Economic Order Quantity (EOQ) is closely related to cost accounting as it helps in optimizing inventory costs and informs decision-making in cost management. Cost accounting involves measuring, analyzing, and reporting the costs of producing goods or services.
By using EOQ, cost accountants can determine the most cost-effective order quantity that minimizes both holding costs and ordering costs. This information is crucial in budgeting, pricing decisions, and overall cost control.
EOQ provides valuable insights into the cost structure of inventory management, allowing businesses to allocate resources efficiently and make informed decisions. It helps in aligning cost accounting with inventory management strategies for better financial performance.
| 5. What are the limitations of using Economic Order Quantity (EOQ) in inventory management? | |
Ans. While Economic Order Quantity (EOQ) is a useful tool in inventory management, it has certain limitations:
1. Assumptions: EOQ assumes that demand is constant, ordering and holding costs are known and stable, and there are no quantity discounts. These assumptions may not always hold true in real-world scenarios.
2. Inaccurate demand forecasts: EOQ calculations rely on accurate demand forecasts. If demand fluctuates significantly or is difficult to predict, the EOQ may not provide optimal results.
3. Limited to certain inventory items: EOQ is most suitable for inventory items with stable demand and predictable costs. It may not be as effective for perishable goods, fashion items, or products with highly uncertain demand.
4. Ignores lead time: EOQ does not consider the lead time required to receive the ordered inventory. This can lead to stockouts if lead time is significant.
5. Ignoring storage constraints: EOQ assumes unlimited storage capacity, which may not be feasible for businesses with limited warehouse space. This can lead to additional costs or inefficiencies in managing inventory.
Text Transcript from Video
hi welcome back ambu shhhhh this is my
third video in this series on inventory
management in this video we are going to
discuss what is popularly known as
economic order quantity or yoke you uqs
a beautiful introductory model that
helps us understand inventory management
if you've seen video number two we said
the objective of inventory management is
to minimize cost and there are two
categories of cost that we have here one
is the cost of having too much okay you
have too much inventory and there are
cost associated with this and there are
also cost of having too little so if you
have too little inventory there are cost
associated objective of inventory
management is to minimize the sum of
these two cause now you queue just takes
one cost share of too much and one costs
here or too little so the cost involved
here of too much is what we call as the
holding cost this includes the inventory
or the carrying cost or whatever the
space cost of carrying too much and the
cost of too little what euq talks about
is what we call as the ordering cost
because I carry too little I have to
order frequently and I would need more
people to order I would need more
paperwork so so what you queue does as a
model it seeks to optimize or minimize
the sum of the holding and ordering cost
that's the iake model now let's
understand the entire concept of
inventory management as when yo Q now
let's have to access suppose this is my
y axis which talks about inventory this
is my x axis which talks about time this
is time T this is inventory I now
whenever I am in this situation my
inventory what happens I start with some
level of inventory something here I use
up my inventory uniformly as soon as I
reach 0 I again get some more inventory
and the inventory comes to me and I
start using up at the same uniform rate
again so I'm using it in a firm rate I
reach close to zero
again I get some new material and I
start using up at a uniform rate and the
story continues of this is what is the
EO commodity now the e oq modulus has
lots of assumption that it says the
demand is uniform like you saying you
use at a constant rate and the rate is
known the delivery as soon as I reach
zero the material comes up so it's
perfect reliable and instant and the
holding cost or the carrying cost and
the ordering cost are known and are
constant they don't change so those are
the assumptions that we have in uhyou
model now let's look at an excel sheet
and try and understand how the concept
of yo'ii works I have an excel sheet
here there is a yearly demand of 4,000
units the holding cost is 5 rupees or 5
dollars per unit per year and the
ordering cost is 100 rupees or 100
dollars per order let's assume I take
seven different situations 7 cases case
1 case 2 I use Excel to give me the
meaning K 6 + k 7 so let's assume my
order quantity Q in each case I could
say order 50 units I could order 100
units at one time I could order 200
units or 400 or 500 thousand or say 2000
units each time so these are different
ways so I need 4000 units here that's
fine that's constant but these are seven
different ways I'm considering in in so
that I can order 4000 units in a year i
order 50 every time i order 200 every
time and so on and so forth now since i
need i order 550 every time let's go
back to our main sheet what happens is
here this is 50 okay I allow it to read
zero if I'm ordering say 500 every time
I'm ordering 500
to read zero now my holding cost if you
look is rupees five per unit per year I
am NOT carrying a constant quantity the
quantity that I am carrying is changing
from the maximum which is 50 or 100 or
500 to something zero so obviously the
inventory carrying cost will be on the
average and the average is the maximum
plus minimum divided by two and since my
minimum here is zero its maximum divided
by two so my average inventory on which
I will apply the holding cost average
inventory is maximum plus minimum
divided by two which is in this case he
said its maximum divided by two is equal
to 50 divided by 2 this is my average
inventory in each case I will copy this
formula and the my total holding cost
will be equal to this average inventory
multiplied by cost of holding per unit
per year so 125 rupees in this case and
in the last case I need to fix up I need
to fix this dollar so that I can copy
the formula so in the maximum case I
will incur 5,000 as sign and rebuilding
cost and here I Lord 125 rupees all
right now since I'm ordering 50 each
time and I need 4000 my number of orders
n which is number of orders would be
equal to 4000 divided by my order size
50 so my order size is 80 I place 80
orders here let me fix up this the
tagging copy ctrl C I paste it and so so
when I'm ordering thousand and I need
five four thousand my order of number of
orders is for my ordering cost is rupees
100 or $100 per order so my total
ordering cost becomes the number of
orders times cost per order and I copy I
fix up this
dollars and I then copy this formula
Excel mix copying easy so I'm ordering
it four times so it's four hundred 100
per order so the total cost associated
with inventory here is the holding cost
plus the ordering cost so eight thousand
one hundred twenty five rupees I copy
this and I get different values of cost
the objective of your queue is to
minimize so as for this sheet I should
order four hundred units because my cost
involved here is minimum let's make a
graph to understand it and so that it
becomes easier I'll hide a few rows I
will hide this and I leave them I hide
the number of orders and so I am queue
and because so I will select it and
insert a scatter chart Here I am scatter
chart so this is what we get I will
switch the axis select data switch
column and row wonderful this is my
scatter chart so I just shift it to the
side so that we get a better view of the
data as well as the chart now what's
happening look my order size keeps on
increasing from fifty two hundred to two
hundred to four hundred the total
ordering cost keeps coming down because
obviously when you order larger
quantities in one batch the number of
orders will reduce but your holding cost
which is this which is you look at it
here keeps on increasing so this line is
the total cost and this find the total
cost of the minimum and and by some
chance the total cost is minimum at the
point where holding and the ordering
cost unequal so this if I drop a line
here the line will drop to 500 or sorry
400 where the cost
minimum let's get back to a sheet and
understand so what I can do one thing I
can do here is I'll paste the chart here
for every situation I can follow the
same principle make in various cases and
can make this graph and find the
lowest-cost and so this is my UQ 400 or
I can use the e oq formula which is the
simple one here UQ means economic order
quantity is the square root of two times
the cost of ordering or cost per order
into the yearly demand divided by the
total by the cost of holding per unit
per here so now let's try and create
this formula so we have some data which
we'll use from the numerical which
weights are the yearly demand was a
4,000 units the cost of ordering was
rupees 100 per order cost of holding
five per year so my EU q EO q that I
have is equal to square root I go as per
this formula two times cost of ordering
which is 100 times 4,000 so this four
thousand is also under root divided by
five so when I expand this formula five
and this five times eight and is 4000
eight hundred so what I get is square
root of 800 and so eight thousand eighty
thousand 16 and one two three four zeros
and this is nothing but four hundred
units and is the same thing which you
have got by this graphical analysis so
this is a very simple understanding of
what your Q is and how to calculate your
Q by this formula I hope you like this
formula and like this video please do
share it with your friends
and leave your comments to help improve
better stay tuned we'll have two more
videos to help you understand the entire
topic of inventory management thank you
for watching goodbye
third video in this series on inventory
management in this video we are going to
discuss what is popularly known as
economic order quantity or yoke you uqs
a beautiful introductory model that
helps us understand inventory management
if you've seen video number two we said
the objective of inventory management is
to minimize cost and there are two
categories of cost that we have here one
is the cost of having too much okay you
have too much inventory and there are
cost associated with this and there are
also cost of having too little so if you
have too little inventory there are cost
associated objective of inventory
management is to minimize the sum of
these two cause now you queue just takes
one cost share of too much and one costs
here or too little so the cost involved
here of too much is what we call as the
holding cost this includes the inventory
or the carrying cost or whatever the
space cost of carrying too much and the
cost of too little what euq talks about
is what we call as the ordering cost
because I carry too little I have to
order frequently and I would need more
people to order I would need more
paperwork so so what you queue does as a
model it seeks to optimize or minimize
the sum of the holding and ordering cost
that's the iake model now let's
understand the entire concept of
inventory management as when yo Q now
let's have to access suppose this is my
y axis which talks about inventory this
is my x axis which talks about time this
is time T this is inventory I now
whenever I am in this situation my
inventory what happens I start with some
level of inventory something here I use
up my inventory uniformly as soon as I
reach 0 I again get some more inventory
and the inventory comes to me and I
start using up at the same uniform rate
again so I'm using it in a firm rate I
reach close to zero
again I get some new material and I
start using up at a uniform rate and the
story continues of this is what is the
EO commodity now the e oq modulus has
lots of assumption that it says the
demand is uniform like you saying you
use at a constant rate and the rate is
known the delivery as soon as I reach
zero the material comes up so it's
perfect reliable and instant and the
holding cost or the carrying cost and
the ordering cost are known and are
constant they don't change so those are
the assumptions that we have in uhyou
model now let's look at an excel sheet
and try and understand how the concept
of yo'ii works I have an excel sheet
here there is a yearly demand of 4,000
units the holding cost is 5 rupees or 5
dollars per unit per year and the
ordering cost is 100 rupees or 100
dollars per order let's assume I take
seven different situations 7 cases case
1 case 2 I use Excel to give me the
meaning K 6 + k 7 so let's assume my
order quantity Q in each case I could
say order 50 units I could order 100
units at one time I could order 200
units or 400 or 500 thousand or say 2000
units each time so these are different
ways so I need 4000 units here that's
fine that's constant but these are seven
different ways I'm considering in in so
that I can order 4000 units in a year i
order 50 every time i order 200 every
time and so on and so forth now since i
need i order 550 every time let's go
back to our main sheet what happens is
here this is 50 okay I allow it to read
zero if I'm ordering say 500 every time
I'm ordering 500
to read zero now my holding cost if you
look is rupees five per unit per year I
am NOT carrying a constant quantity the
quantity that I am carrying is changing
from the maximum which is 50 or 100 or
500 to something zero so obviously the
inventory carrying cost will be on the
average and the average is the maximum
plus minimum divided by two and since my
minimum here is zero its maximum divided
by two so my average inventory on which
I will apply the holding cost average
inventory is maximum plus minimum
divided by two which is in this case he
said its maximum divided by two is equal
to 50 divided by 2 this is my average
inventory in each case I will copy this
formula and the my total holding cost
will be equal to this average inventory
multiplied by cost of holding per unit
per year so 125 rupees in this case and
in the last case I need to fix up I need
to fix this dollar so that I can copy
the formula so in the maximum case I
will incur 5,000 as sign and rebuilding
cost and here I Lord 125 rupees all
right now since I'm ordering 50 each
time and I need 4000 my number of orders
n which is number of orders would be
equal to 4000 divided by my order size
50 so my order size is 80 I place 80
orders here let me fix up this the
tagging copy ctrl C I paste it and so so
when I'm ordering thousand and I need
five four thousand my order of number of
orders is for my ordering cost is rupees
100 or $100 per order so my total
ordering cost becomes the number of
orders times cost per order and I copy I
fix up this
dollars and I then copy this formula
Excel mix copying easy so I'm ordering
it four times so it's four hundred 100
per order so the total cost associated
with inventory here is the holding cost
plus the ordering cost so eight thousand
one hundred twenty five rupees I copy
this and I get different values of cost
the objective of your queue is to
minimize so as for this sheet I should
order four hundred units because my cost
involved here is minimum let's make a
graph to understand it and so that it
becomes easier I'll hide a few rows I
will hide this and I leave them I hide
the number of orders and so I am queue
and because so I will select it and
insert a scatter chart Here I am scatter
chart so this is what we get I will
switch the axis select data switch
column and row wonderful this is my
scatter chart so I just shift it to the
side so that we get a better view of the
data as well as the chart now what's
happening look my order size keeps on
increasing from fifty two hundred to two
hundred to four hundred the total
ordering cost keeps coming down because
obviously when you order larger
quantities in one batch the number of
orders will reduce but your holding cost
which is this which is you look at it
here keeps on increasing so this line is
the total cost and this find the total
cost of the minimum and and by some
chance the total cost is minimum at the
point where holding and the ordering
cost unequal so this if I drop a line
here the line will drop to 500 or sorry
400 where the cost
minimum let's get back to a sheet and
understand so what I can do one thing I
can do here is I'll paste the chart here
for every situation I can follow the
same principle make in various cases and
can make this graph and find the
lowest-cost and so this is my UQ 400 or
I can use the e oq formula which is the
simple one here UQ means economic order
quantity is the square root of two times
the cost of ordering or cost per order
into the yearly demand divided by the
total by the cost of holding per unit
per here so now let's try and create
this formula so we have some data which
we'll use from the numerical which
weights are the yearly demand was a
4,000 units the cost of ordering was
rupees 100 per order cost of holding
five per year so my EU q EO q that I
have is equal to square root I go as per
this formula two times cost of ordering
which is 100 times 4,000 so this four
thousand is also under root divided by
five so when I expand this formula five
and this five times eight and is 4000
eight hundred so what I get is square
root of 800 and so eight thousand eighty
thousand 16 and one two three four zeros
and this is nothing but four hundred
units and is the same thing which you
have got by this graphical analysis so
this is a very simple understanding of
what your Q is and how to calculate your
Q by this formula I hope you like this
formula and like this video please do
share it with your friends
and leave your comments to help improve
better stay tuned we'll have two more
videos to help you understand the entire
topic of inventory management thank you
for watching goodbye
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Nov 15, 2024 Last updated |
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