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Random article

Economic order quantity

Management accounting.

(EOQ).

The optimal size of orders and frequency for ordering stocks or raw materials based on the periodic demand (D), the fixed ordering cost (F) and

the periodic holding cost (H) of the item of stock in question.


Expressed as a formula:

EOQ = (2FD / H)(1/2)


Where:

F = the Fixed cost per order (eg £20)

D = the annual Demand, or usage, of the item (eg 100 units)

H = annual Holding cost per unit of the item (eg £40)


Example 1

In this case:

EOQ = (2FD / H)(1/2)

= (2 x £20 x 100 / £40)(1/2)

= 10 units per order.


With this size of order, the average number of orders per year would be

100 / 10 = 10 orders.


Total annual ordering costs

= 10 orders x £20/order

= £200.


Average stock levels would be

10 / 2 = 5 units.


Total annual stock holding costs

= 5 units x £40/unit

= £200.


Grand total costs

= £200 + £200

= £400.


Example 2

Total costs would be greater with any other number of unit


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