Economic Order Quantity
Bus M361-2
Sabrina Wu
11/28/2005
Economic Order Quantity
Definition of EOQ
How to use the EOQ model in a
business organization
How the EOQ model works
Real world example
The Definition of EOQ
EOQ, or Economic Order Quantity, is
defined as the optimal quantity of orders
that minimizes total variable costs required
to order and hold inventory.
How to use EOQ in your organization
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.
How EOQ Works
The Principles Behind EOQ: The Total Cost Curve
&

How EOQ Works
The Principles Behind EOQ: The Holding Costs
Keeping inventory on hand
Interest
Insurance
Taxes
Theft
Obsolescence
Storage Costs
How EOQ Works
The Principles Behind EOQ: The Holding Costs
Interest
Obsolescence
Storage
How EOQ Works
The Principles Behind EOQ: The Procurement Costs
Primarily the labor costs associated
with processing the order:
Ordering and requisition
A portion of the freight if the amounts
vary according to the size of the order
Receiving, inspecting, stocking
Invoice processing
How EOQ Works
The Total Cost Formula
Total Cost = Purchase Cost + Order Cost + Holding Cost
How EOQ Works
The Total Cost Formula
This represents the
unchanging fixed costs
P = Purchase cost per unit
R = Forecasted monthly usage
How EOQ Works
The Total Cost Formula
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
How EOQ Works
The Total Cost Formula
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
How EOQ Works
The EOQ Formula
Total Cost
Formula
Taking the derivative of both sides of the equation and setting equal to
zero to find the minimum value of the function, one obtains:
How EOQ Works
The EOQ Formula
The result of differentiation
The Economic Order Quantity
How EOQ Works
The EOQ Formula
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
How EOQ Works
The EOQ Formula
Review and Summary of the EOQ Formula
Here is the a graphic representation of the EOQ equation
Real Life Example:
Real Life Example:
Real Life Example:
First, Recall the
EOQ Equation:
P = Purchase cost per unit
R = Forecasted monthly usage
C = Cost per order event (not per unit)
F = Holding cost factor
Real Life Example:
Next let’s identify the
correct variables…
Real Life Example:
Next let’s identify the
correct variables…
Forecasted
Amount
Real Life Example:
Next let’s identify the
correct variables…
Ordering
Costs
Real Life Example:
Next let’s identify the
correct variables…
Cost per
Unit
Real Life Example:
Next let’s identify the
correct variables…
Holding
Cost Factor
Real Life Example:
R = Annual demand
C = Fixed ordering cost
P = Cost per case
F = Holding Cost Factor
Real Life Example:
R = 5200
C = $10 per order
P = $2
F = 20% of value of
inventory per year
Real Life Example:
R = 5200
C = $10 per order
P = $2
F = 20% of value of
inventory per year
EOQ =
2(10) (5200)
(2 )(.20)
Real Life Example:
EOQ =
2(10) (5200)
(2 )(.20)
EOQ = 510 cases
Wrapping It Up
EOQ, or Economic Order Quantity, is defined as the optimal
quantity of orders that minimizes total variable costs required to
order and hold inventory.
Closing Comments
EOQ is a tool, not a simple solution.
EOQ is useful in determining optimal order
quantity
Understand the equation and what you are
trying to find
Find accurate inputs for the equation
Additional Resources on EOQ
• http://www.findarticles.com/p/articles/mi_m0KAA/is_5_31/
ai_94771293
• http://www.inventoryops.com/economic_order_quantity.htm
• http://en.wikipedia.org/wiki/Economic_order_quantity