Economic Order Quantity (EOQ)

A decision about how much to order has great significance in inventory management. The quantity to be purchased should neither be small nor big because costs of buying and carrying materials are very high. 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 costs. Generally, economic order quantity is the point at which inventory carrying costs are equal to order costs. In determining economic order quantity it is assumed that cost of managing inventory is made up solely of two parts i.e., ordering costs and carrying costs.

(A) Ordering costs- These are the costs which are
associated with the purchasing or ordering of materials.

1.These costs include.

2.Expenses incurred on transportation of goods purchased.

3.Inspection costs of incoming materials.

4.Cost of stationery, typing, postage, telephone
charges, etc.,

These costs are also known as buying costs and will arise only when some purchases are made. When materials are manufactured in the concern then these costs will be known as set-up costs. These costs will include costs of setting up machinery for manufacturing materials, time taken up in setting, cost of tools, etc.,

The ordering costs are totaled up for the year and then.divided by the number of orders placed each year. The Planning Commission of India has estimated these costs between Rs. 10 to Rs. 20 per order.2Costs of staff posted for ordering of goods. A purchase order is processed and then placed with suppliers. The labour spent on this process is includednin ordering costs.

(B) Carrying Costs- These are the costs for holding the inventories. These costs will not be incurred if inventories are not carried. These costs include.

1.The cost of capital invested in inventories. An interest will be paid on the amount of capital locked-up in inventories.

2.Cost of storage which could have been used for other purposes.

3.The loss of materials due to deterioration and obsolescence. The materials may deteriorate with passage of time. The loss of obsolescence arises when the material in stock are not usable because of chanhe in process or product.

4.Insurance cost.

5.Cost of spoilage in handling of materials.

The Planning Commission of India had estimated
these costs between 15 per cent to 20 per cent of total costs. The longer the materials kept in stocks, the costlier it becomes by 20 per cent every year.

The ordering and carrying costs of materials being high, an effort should be made to minimise these costs. The quantity to be ordered should be large so that economy may be made in transport costs and discounts may also be earned. On the other hand, storing facilities, capital to be locked up, insurance costs should also be taken into account. materials in stock are not usable because of change in process or product.

Assumptions of EOQ- While calculating EOQ the
following assumptions are made.

1.The supply of goods is satisfactory. The goods can be purchased whenever these are needed

2.The quantity to be purchased by the concern is certain.

3.The prices of goods are stable. It results to stabilise carrying costs.