Economic Order Quality

ECONOMIC ORDER QUALITY
 
The Economic Order Quantity (EOQ) is thenumber of units that a company should addto inventory with each order to minimize thetotal costs of inventory²such as holdingcosts, order costs, and shortage costs. TheEOQ is used as part of a continuous reviewinventory system, in which the level of inventory is monitored at all times, and afixed quantity is ordered each time theinventory level reaches a specific reorder   point. The EOQ provides a model for calculating the appropriate reorder point andthe optimal reorder quantity to ensure theinstantaneousreplenishment of inventorywith no shortages. It can be a valuable toolfor small business owners who need to makedecisions about how much inventory to keepon hand, how many items to order eachtime, and how often to reorder toincur thelowest possible costs.    
The EOQ model assumes that demand isconstant, and that inventory is depleted at afixed rate until it reaches zero. At that point,a specific number of items arrive to returnthe inventory to its beginning level. Sincethe model assumes instantaneousreplenishment, there are no inventoryshortages or associated costs. Therefore, thecost of inventory under theEOQmodelinvolves atradeoff between inventoryholding costs (the cost of storage, as well asthe cost of tying up capital in inventoryrather than investing it or using it for other   purposes) and order costs (any feesassociated with placing orders, such asdelivery charges). Ordering a large amountat one time will increase a small business'sholding costs, while making more frequentorders of fewer items will reduce holdingcosts but increase order costs. The EOQ    
model finds the quantity that minimizes thesum of these costs.The basic EOQ formula is as follows:TC = PD + HQ/2 + SD/Qwhere TC is the total inventory cost per year, PD is the inventory purchase cost per year (price P multiplied by demand D inunits per year), H is the holding cost, Q isthe order quantity, and S is the order cost...