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Economic
Order Quantity
This
is the volume or the quantity of material which the firm should order to
maintain for minimizing the overall cost of inventory.
In
EOQ, there are three types of inventory are exist.
1.
Cost of Material
2.
Ordering Cost
3.
Carrying Cost/ Holding Cost
1. Cost
of Material includes the cost of raw material
2. Ordering
Costconsist:
1.
Cost of requisition is the costs which are arise at the time of
analyzing what type of material is needed, how much is needed.
2.
Cost of information is arising at the time of collecting information
regarding the raw material from suppliers, vendors.
3.
Cost of Tendering have a cost of preparing a tender notice for calling
the quotation of material.
4.
Cost of placing order is come after analyzing the best material at low
cost. It consist transportation and insurance expenses also till the godown.
5.
Cost of unloading and cartage expenses are comes under this cost.
6.
Cost of inspection is the expense of inspecting the material.
7.
Cost of storage of material in the godown
3. Carrying
Cost/ Holding Cost
1.
Cost of holding the material and rent of godown and warehouses
2.
Cost of insurance of goods in the godown but in case of own godown, depreciation would be
charged.
3.
Salary or wage to the guard
4.
Interest on capital block
5. Obsolescence/spoilage/ wastage
We
should have that size of inventory in which ordering cost and carrying cost
should be minimum which is known as optimal order size or EOQ.
EOQ refers to optimal order size that results
into lowest total ordering cost and
carrying cost for an item of inventory at its given expected usage carrying
cost and ordering cost.
A =
Annual usage
Cp
= Ordering cost per order
Ch
= Carrying cost per unit
Drawbacks
of EOQ
1.
Demand of the product uniform throughout the year.
2.
Price of the material, carrying cost and ordering cost remains constant.
3.
This theory assumes supply of material is strictly in time which is not
absolute and real.
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