Economic Order Quantity

Topics: Cost, Costs, Economic order quantity Pages: 7 (2031 words) Published: November 4, 2012

1. Executive Summary -03

2. Introduction -03

3. Objective of study -06

4. Research Methodology -06

5. Analysis and interpretation of data -07-13

6. Conclusion -13

7. References -15

Inventory management is big issue today, it gives one company competitive edge over other companies. The word inventory refers to any kind of resource having economic value and is maintained to fulfill the present and future needs of an organization. Fred hansman defined inventory as an idle resource of any kind provided such a resource has economic value. Inventory of resources is held to provide desirable service to customers and to achieve sales turnover target. Investment in large inventories adversely affects firm’s cash flow and working capital as investment in inventory represents substantial portion of total capital investment in any business. It is in therefore essential to balance the advantage of having inventory of resources and the cost of maintain it so as to determine an optimal level of inventory of each resource so that total inventory cost is minimum. Holding of stock is expensive so controls are needed to ensure that stock level remains as low as possible. Stocks should be controlled using rational policies to balance between holding cost and demand. One such policy is ordering ECONOMIC ORDER QUQNTITY for stock replenishment at this point holding cost reduces significantly and total annual inventory cost is lowest. Though maintaining exact EOQ is sometime not possible working in the vicinity of it results in lower total annual inventory cost. Holding cost is straight line that is it directly varies with ordering quantity (according to classic EOQ model) is fairly true if product is non perishable, but in real life situation and specially in the case of perishable item it is a curve, we will see it through data provided by Spenser’s mall through examples and regression analysis. This happens because in case of perishable items holding cost is not constant again threat of spoilage forces companies to adopt mark down policy. We will check through linear regression the relation of holding cost with time and quantity that it is a curve in case of perishable items.

In the era of recession every firm is trying to cut their cost and inventory cost plays a vital role in this. Managing inventory properly is an important means of controlling costs and, thereby, improving the profitability of firm. Since a higher quantity is not best … and a lower quantity is not best … there must be some “Economic order quantity (EOQ)” which minimizes the total variable costs of inventory. Total variable costs are usually computed on an annual basis and include two components, the costs of ordering and holding inventory.

Annual ordering cost is the number of orders placed times the marginal or incremental cost incurred per order. This incremental cost includes several components: - The costs of preparing the purchase order, paying the vendor's invoice, and inspecting and handling the material when it arrives.  It is difficult to estimate these components precisely but a ballpark figure is good enough.

The holding costs used in the EOQ should also be marginal in nature. Holding costs include insurance, taxes, and storage charges, such as depreciation or the cost of leasing a warehouse. Some of the firms also include the interest cost of the money tied up in inventory. In classic EOQ model as the quantity increases holding cost increases proportionally i.e. it remains linear to the function of time but in real life the cumulative holding cost is a convex function of time curve because the...
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