ECONOMIC ORDER QUANTITY

·  ECONOMIC ORDER QUANTITY
INVENTORY MANAGEMENT TECHNIQUES
OPERATION MANAGEMENT

   OVERVIEW

1. ECONOMIC ORDER QUANTITY IS THE ORDER QUANTITY THAT MINIMIZES THE TOTAL HOLDING COST AND ORDERING COST.
2. ONE OF THE OLDEST CLASSICAL PRODUCTION SCHEDULING MODELS DEVELOPED BY FORD W.HARRIS IN 1913 BUT R.H.WILSON WHO USED IT A LOT AND K .ANDLER ARE GIVEN CREDIT FOR THEIR IN DEPTH ANALYSIS.
3. ECONOMIC ORDER QUANTITY IS THE SIZE OF THE LOT TO BE PURCHASED WHICH IS ECONOMICALLY VIABLE. THIS IS THE QUANTITY OF MATERIALS WHICH CAN BE PURCHASED AT MINIMUM COST. ECONOMIC ORDER QUANTITY IS THE POINT AT WHICH INVENTORY CARRYING COSTS ARE EQUAL TO ORDER COSTS.
4. TOTAL COST OF A MATERIAL =TOTAL  ACQUISITION COST + TOTAL ORDERING COST + TOTAL CARRYING COST

   ASSUMPTIONS OF EOQ

1. DEMAND IS KNOWN AND CONSTANT
2. THE LEAD TIME IS KNOWN AND CONSTANT
3. THE RECEIPT OF THE INVENTORY IS IMMEDIATELY
4. QUANTITY DISCOUNT ARE NOT AVAILED
5. THE ONLY VARIABLE COSTS ARE THE COSTS OF PLACING AN ORDER(ORDERING QUANTITY) AND THE COST OF HOLDING OR STORING INVENTORY
6. IF ORDERS ARE PLACED AT THE RIGHT TIME,STOCK OUT OR SHORTAGE CAN BE COMPLETELY AVOIDED.

• COST OF INVENTORY
• THIS REFERS TO THE NOMINAL COST OF INVENTORY. IT IS THE PURCHASE PRICE FOR THE ITEM UNIT IF IT IS PURCHASED FROM THE MARKET AND COST OF PRODUCTION IF THE ITEM IS PRODUCED IN THE ORGANIZATION IT SELF. THE COMPONENT OF THE COSTS ARE:-

I.            DIRECT MATERIAL COST

II.            DIRECT LABOUR COST

III.            DIRECT EXPENSES

IV.            OVERHEAD COSTS

V.            PROFIT OF THE MANUFACTURE

   EXPLANATION OF ORDERING COST

ORDERING COSTS ARE THE EXPENSES INCURRED TO CREATE AND PROCESS AN ORDER TO SUPPLIER. THESE COSTS ARE INCLUDED IN THE DETERMINATION OF THE ECONOMIC ORDER QUANTITY.

I.            COST TO PREPARE PURCHASE REQUISITION.SENDING INQUIRIES,RECEIVING QUOTATIONS

II.            COST TO PURCHASE ORDER,FOLLOW UP THE ORDER

III.            TRANSPORTATION COST AND STATIONERY COST

IV.            RENT FOR THE SPACE USED BY THE PURCHASE DEPARTMENT

V.            THE SALARIES AND WAGES OF OFFICERS AND STAFF IN THE PURCHASING DEPARTMENT

VI.            INSPECTION COST AND COST OF SETTLEMENT FOR PAYMENT

   CARRYING COSTS

   IT  IS THE COST OF HOLDING THE MATERIALS IN THE STORE .THEY ARE ALSO CALLED HOLDING COST OR STORAGE COSTS

1.       COST OF STORAGE SPACE/RENT OF THE WAREHOUSE,DEPRECIATION OF THE WAREHOUSE,SALARIES OF THE STOREKEEPER

2.       COSTS OF BINS AND RACKS

3.       COST OF MAINTAINING  THE MATERIAL

4.       AMOUNT OF INTEREST

5.       TRANSPORTATION COSTS IN RELATION TO STOCK

6.       COST OF OUT DATED NESS

7.       COST OF INSURANCE

8.       CLERICAL COSTS

9.       ANY LOSS DUE TO PILFERAGE AND DETERIORATION

   STOCK OUT COSTS

1.       IT MEANS SHORTAGE. COST ASSOCIATED WITH NOT SERVING THE CUSTOMERS.

2.       IF STOCK OUT IS INTERNAL:-CAUSING PRODUCTION STOPPAGE

3.       IF THE STOCK OUT IS EXTERNAL IT WOULD RESULT IN A LOSS OF POTENTIAL SALES AND LOSS OF CUSTOMERS GOODWILL

   DETERMINISTIC MODELS

   THESE ARE BASED ON THE CONDITIONS OF CERTAINTY OF DEMAND

   ALSO ASSUMED THAT DEMAND REMAINS UNIFORM THROUGHOUT THE PERIOD

   POSSIBLE TO PLACE ORDER FOR A FIXED QUANTITY ONCE THE INVENTORY REACHES AT CERTAIN LEVEL

   AS THERE IS NO TIME LAG AS THE REPLENISHMENT IS INSTANT

   NO SHORTAGE

   DETERMINISTIC MODEL

    

    

   METHODS OF ECONOMIC ORDER DETERMINATION

1.       GRAPHIC METHOD

2.       ALGEBRIC METHOD

3.       TABULAR METHOD

   GRAPHIC METHOD

   DIAGRAM

    

   ALGEBRAICALLY

EOQ=√(2AO/C)   WHERE A = ANNUAL CONSUMPTION

S OR O =COST OF PLACING AN ORDER

I OR C =INVENTORY CARRYING COSTS OF ONE UNIT

 STEP BY STEP PROCEDURE TO CALCULATE ECONOMIC ORDER ANTIQUITY

ANNUAL ORDERING COST=NO OF ORDER PLACED PER YEAR X ORDERING COST PER ORDER

=(ANNUAL DEMAND/NO OF UNITS IN EACH ORDER)ORDERING COST PER ORDER

(A/Q)X O

   ANNUAL HOLDING OR CARRYING COST=AVERAGE INVENTORY X CARRYING COST/UNI/YEAR

   (Q/2)X C

   OPTIMAL ORDERING QUANTITY IS WHERE ORDERING COST=CARRYING COST

   FORMULA

   (A/Q)X O = (Q/2)X C

   HERE AFTER  CROSS MULTIPLICATION

   Q²⁼ 2AO/C

   Q=√(2 AO/C)

   PROBLEM

MONTHLY DEMAND =4000. THE PRODUCT REQUIRES A COMPONENT X  AT RS 20 PER UNIT. THE ORDERING COST IS RS 120 PER ORDER AND THE HOLDING COST IS 10% P.A

   SOLUTION

   EOQ=√(2AO/C)

   ANNUAL CONSUMPTION IN UNITS =4000X12=48,000

   O= 120 RS

   C =20X10/100 =2

   EOQ=√(2X48000X120/2)= √(96000X60)= √5 7,60,000

   2400 UNITS

   CRITICISM

WRONG ASSUMPTION  OF:

1.       CONSTANT DEMAND

2.       NO CHANGE IN THE UNIT PRICE

3.       CONSTANT CARRYING COST

4.       IMMEDIATE DELIVERY/NO LEAD TIME