What is Economic Order Quantity?

The economic order quantity (EOQ) is the amount of inventory to be ordered

at one time for purposes of minimizing annual inventory cost
although
TOTAL COST= PURCHASE COST+ORDERING COST+
HOLDING COST
In EOQ we want to minimize inventory related costs which are other than purchase
price costs.

So for EOQ we have to minimize our total cost which is

TOTAL COST= ORDERING COST+CARRYING COST
PURCHASE PRICE COSTS IS AS FOLLOWS:xxxxxxxx

OTHER THAN PURCHASE PRICE COST

Ordering cost
Ordering costs

Clerical/labor costs of
processing orders
Inspection and return of poor
quality products
Transport costs
Handling costs

Carrying cost
Holding costs

Storage costs

Rent/depreciation

Labor

Overheads (e.g. heating, lighting,

security)

Money tied up (loss of interest,

opportunity cost)

Obsolescence costs (if left with stock

There are two costs attached to stock:

1) Ordering Cost: All cost which are incurred during the ordering
of stock, like phone calls, transportation cost, etc
2) Holding Cost: Storage costs, like rent of the building,
insurance, finance cost, wear & tear, inventory obsolescence etc
Now if we purchase all the required material in a single order,
although we can save Ordering Cost, but Holding Cost would be
high, and if we purchase our material in several shipments,
holding cost would be lowered, but Ordering Cost would be high.
So, Economic Order Quantity is the balance between these two
costs. Economic Order Quantity is cheapest taken as a whole. At
EOQ, both ordering cost and holding cost are equal

EOQ=

2 AD OC /ORDER
CC /UNIT

AD= ANNUAL DEMAND/ ANNUAL USAGE/ ANNUAL CONSUMPTION

CC= CARRYING COST/ HOLDING COST

Note : For Calculating EOQ

ordering cost= ordering cost fixed per order ( do not take ordering
cost variable per order)
Carrying cost= carrying cost variable per unit ( do not take
carrying cost fixed per unit)

Total annual ordering cost

TOTAL NUMBER OF ORDERS

( on basis of eoq)

AD
EOQ

TOTAL ANNUAL ORDERING COST= TOTAL NUMBER OF ORDERS PRICE PER

ORDER

Total annual carrying cost

AVERAGE INVENTORY

( on basis of eoq)

EOQ
2

TOTAL ANNUAL CARRYING COST = AVERAGE INVENTORY PRICE PER UNIT

NOTE: at EOQ TOTAL ANNUAL ORDERING COST= TOTAL ANNUAL

CARRYING COST
the cost ( TOTAL ANNUAL ORDERING COST+ TOTAL ANNUAL CARRYING COST) at EOQ is the
minimum cost every other order other than EOQ will give more cost.

SPECIAL CASE ( on basis of other than eoq)

When vendor or supplier gives special discount on certain order or quantity
quoted by him, then in calculation of total annual ordering cost and total
annual carrying cost use that order size or quantity in formulas instead of
EOQ .

If that particular discounted price order size gives ( TOTAL ANNUAL ORDERING COST+
TOTAL ANNUAL CARRYING COST) minimum cost which is less, as compare to using EOQ
( TOTAL ANNUAL ORDERING COST+ TOTAL ANNUAL CARRYING COST) then in that special
circumstance we will be using that special order size not EOQ.
And never forget to give effect of discounted price in (PRICE PER ORDER)