Page 119 - DMGT525_MATERIALS_MANAGEMENT

Materials Management

Notes How Much to Order?

After solving the problem of ‘when to order’ the next immediate issue is ‘how much to order’.
Considering overbuying can lead to unproductive use of working capital and under-buying
leads to unwanted emergency orders and ultimately increases the workload of the purchase
department, the issue of ‘how much to order’ is of vital significance.
Hence, a balance is achieved by selecting the right quantity for each order. This quantity in short
is known as Economic Order Quantity (EOQ).

8.2.1 Economic Order Quantity

EOQ is an important technique of inventory management. The EOQ refers to the optimal order
size that will result in the lowest total of order and carrying cost for an item of inventory given
its expected usage, carrying cost and ordering cost. By calculating an economic order quantity,
the firm attempts to determine the order size that will minimize the total inventory cost.
EOQ is simple to understand and use but it has several restrictive assumptions, which are also
disadvantages in practice. Even with this weakness, EOQ is a good point to start understanding
inventory systems. EOQ assumes:
1. Demand rate is constant, uniform, recurring, and known
2. Lead time is constant and known in advance

3. Price per unit of product is constant; no discounts are given for large orders
4. Inventory holding cost is based on average inventory
5. Ordering or setup costs are constant
6. All demands will be satisfied; no stock outs are allowed
D = Annual demand

C = Ordering cost per order
i
P = Unit price
C = Carrying cost per order
c

EOQ = 2  D C / P C
c i
A Basic EOQ Example

A grocery store sells 10 cases of coffee each week. Each case costs ` 80. The cost of placing an
order is ` 10. Holding or carrying cost is estimated to be 30% of the inventory.

D = 520 case/year
C = ` 10 per order
c
C = 30%
i
P = ` 80 per case




Q = 2 D C /P C i
c

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