Economic Order Quantity

Raw material cost

• This is major cost to manufacturing firms.

• It causes (a high percentage of) ongoing cash outflow for each period.

• It requires very close control over its usage and storage.

queries

• What to order? [EOQ]• When to order? [reorder point]• How much to keep? [safety stock]• How it should be valued? [closing stock calcu]

Costs of inventory

• Purchase and/or inventory [quoted price less discount allowed, plus carriage charges]

• Ordering [associated with preparing, receiving, and paying for an order]

• Storage [carrying cost of keeping one unit in stock for the period]

Economic Order Quantity

• Is an estimate of the number of units per order (that will be the least costly) that will bring balance between the costs of ordering and the costs of holding inventory.

Economic Order Quantity

Where – K is total demand in units, – O is ordering cost– C = carrying cost

Q* = √

Assumptions of EOQ

• Demand rates are known and hardly vary• The cost of item does not vary with order size• All of the order is delivered at one time• The cost to make the order is always the same• Cost of holding stock is linear

Reorder Point

• Is the level of inventory that triggers the placement of an order for additional units.

Daily usage x lead time

• Usage is the quantity used/sold each day• Lead time is the period between

placement and arrival of the units ordered

Safety Stock

• Is the quantity of inventory kept on hand in the vent of fluctuating usage. It impacts the re-order point.

(Daily usage x lead time) + safety stock

• It generally acts as a buffer against stockouts

Stock valuation methods

• Used to calculate the value of the closing stock

• FIFO [closing units x last price(s)]• LIFO [closing units x starting price(s)]• AVCO [closing units x (total spent/total units)]• SIM* [report of actual physical units sold ]

*Specific Identification Method