Inventory Management techniques
The economic order quantity (EOQ)
refers to the optimal order size that will result in the lowest
total of order and carrying costs for an item of inventory given its
expected usage, carrying costs and ordering cost. By calculating an
economic order quantity, the firm attempts to determine the order
size that will minimize the total inventory costs.
Inventory management
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Total inventory cost = Ordering cost
+ Carrying cost
Total ordering costs = Number of orders x Cost per order
= $ U / Q X F
Where
U = Annual usage
Q = Quantity ordered
F = Fixed cost per order
The total carrying costs = Average level of inventory x Price per
unit x Carrying cost (percentage)
Total carrying costs
= $ Q / 2 x P x C
= $ QPC over 2
Where
Q = Quantity ordered
P = Purchase price per unit
C = Carrying cost as %
As the lead-time (i.e., time required
for procurement of material) is assumed to be zero an order for
replenishment is made when the inventory level reduces to zero.
The level of inventory will be equal to the order quantity (Q units)
to start with. It progressively declines (though in a discrete
manner) to level O by the end of period 1. At that point an order
for replenishment will be made for Q units. In view of zero
lead-time, the inventory level jumps to Q and a similar procedure
occurs in the subsequent periods. As a result of this the average
level of inventory will remain at (Q/2) units, the simple average of
the two end points Q and Zero.
From the above discussion the average
level of inventory is known to be (Q/2) units.
From the previous discussion, we know that as order quantity (Q)
increases the total ordering costs will decrease while the total
carrying costs will increase. The economic order quantity, denoted
by Q*, is that value at which the total cost of both ordering and
carrying will be minimized. It should be noted that total costs
associated with inventory
T= $ UF / Q + $QPC / 2 |
