Economic order quantity (EOQ) refers to that number (quantity) ordered in
a single purchase so that the
accumulated costs of ordering and
carrying costs are at the minimum level.

In other words, the quantity that is ordered at one time should be so,
which will minimize the total of (i)
Cost of placing orders and receiving the
goods, and (ii) cost of storing the
goods as well as interest on the capital
invested.

The economic order quantity can be
determined by the following simple
formula:

Where;

EOQ = Economic Order Quantity.

RU = Annually Required Units.

OC = Ordering Costs for one order.

UC = Inventory Unit Cost.

CC = Carrying Cost as %age of Unit Cost.

This formula is based on three assumptions:

1. Price will remain constant throughout the year and quantity discount
is not involved.

2. Pattern of consumption, variable ordering costs per order and variable
inventory carrying charge per unit per
annum will remain the same throughout,
and

3. EOQ will be delivered each time the stock
balance is just reduced to nil.

Carrying cost of inventory consists of (i) the costs of physical storage
such as cost of space, handling and
upkeep expenses, insurance, cost of
obsolescence, etc., and (ii) interest on
capital invested (the opportunity cost
of the capital blocked up). All these
costs are expressed in %age of the cost
per unit.

**
EOQ Graph**

Economic order quantity can also be determined through a graph. Here the
above information is plotted in a graph
for total ordering cost, total carrying
cost and total cost at different
ordering quantities.

The point at which the line of total ordering cost intersects with the
total carrying cost is the EOQ. At this
point the line of total cost will give a
bend that shows the minimum cost.

In the above graph line of total carrying cost intersects line of total
ordering cost at 8,000 order quantities,
where both of the costs are Rs. 12,000.
At this order quantity the total cost is
Rs. 24,000 which is the minimum most.

If the order quantity is increased or decreased the total cost will be
more than the cost at EOQ. This is also
evident from the above graph.

**
Download pdf file of Economic ordering
quantity (EOQ)**