Management Lite & Ezy 38 – Inventory Management II

Part I is here.

The Economic Order Quantity (EOQ) model is a simple inventory-control technique. It is based on several assumptions:

1. Demand is known and constant.
2. Receipt of inventory is instantaneous and complete, i.e. the inventory from an order arrives in one batch at one time.
3. No quantity discount.
4. The only variable costs are inventory holding cost and ordering cost (or setup cost).

With these assumptions, the graph of inventory usage over time has a sawtooth shape, as shown in the diagram below:

The optimum order quantity is the quantity which results in lowest variable costs (inventory holding cost plus ordering cost). It is given by this formula:

Where:

Q* = optimal order quantity

D = annual demand in units for the inventory item

S = setup or ordering cost for each order

H = inventory holding cost per unit per year

Example

The annual demand for an inventory item is 1,000 units; the setup or ordering cost is $10 per order; and the holding cost per unit per year is $0.50. Solving for optimal order quantity:

Reference:

Jay Heizer & Barry Render, “Operations Management”, 8^th edition