Eo q Calculator

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HBS Toolkit License Agreement

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obtained from the use of such information.

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HBS Toolkit LICENSE AGREEMENT


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Contents

Introduction This sheetAnalysis Economic Order Quantity Calculator

Chart Static graphs of typical EOQ outputs with basic descriptions

Overview

Economic Order Quantity (EOQ) is a tool for helping managers decide how much of a given item to

produce or order. It takes into account the main costs associated with acquiring and holdinginventory and finds the optimum trade-off between them. EOQ can be applied to a wide variety of

situations:

A machine in a plant produces two different widgets. How many of each widget

should be produced before the machine is stopped and reset in order to produce the other?

An office manager wants to decide how to order stationery supplies.

A restaurant needs to decide how frequently to have rice delivered.

The components of EOQ are:

1. Cost of setup. This can refer to the downtime a machine has when it is retooled in order toproduce a different product, the direct and indirect costs of ordering supplies, or whatever is

appropriate to the specific decision. It is the additional cost, incurred regardless of volume, thatmust be paid each time you order or produce a run of the product. The larger the amount of product

you order or produce each time, the fewer setups and therefore the lower setup cost. Therefore,high setup costs will tend to lead to larger quantities.

2. Inventory carrying cost rate. This is the estimated annual percentage cost of holding inventory. Itreflects not only the cost of capital, but also storage and movement costs, risk of obsolescence or

damage, etc.

3. Value of inventory per unit. The more expensive the inventory is to produce or order, the more

Economic Order Quantity Calculator INTRODUCTION


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Economic Order Quantity Calculator INTRODUCTION

Other things to bear in mind when using EOQ

As with any formula, your answer can only be as accurate as your assumptions. EOQ is mostlikely to be useful with respect to stable products where demand can reliably be

forecast and where the risk of obsolescence is low.

Remember that as a manager you are not always bound by the constraints in yourenvironment. Setup costs can be reduced if your operations strategy calls for smaller, fasterproduction runs.

To start using the tool, remove the sample data from the tool using the Show/Hide Sample Data optionunder the HBS Menu

Note About Using Internet Explorer

The default setting in Internet Explorer is to open these tools in the Explorer application instead

of Excel. We recommend against this and provide directions in the Help section of the HBSToolkit web site to change this default behavior.

HBS Menu

Show/Hide Sample Data: Displays or removes sample entriesShow Calculator: Launches Windows calculator

Show/Hide Celltips: Toggles in/out red Celltips in documented cellsPrint Sheet with Celltips: Prints Celltip documentation on current sheetSet Zoom: Provides quick access to 80%, 100%, and 125% zoom levelsVisit Web Links: Links to HBS Toolkit website, Toolkit Glossary, and Toolkit

Feedback, as well as HBS and HBS Publishing web sitesAbout HBS Toolkit: Launches the about box for the HBS Toolkit

Jon B. DeFriese MBA `00 and Chad Ellis, MBA `98 developed this software under the supervision ofProfessor Steven Wheelwright as the basis for class discussion rather than to illustrate either the effectiveor ineffective handling of an administrative situation.


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Cost per Setup

Annual Demand

Value of Inventory per Unit

Inventory Carrying Cost RateNumber of Units Produced per Batch

Cost of Carrying Inventory

Cost of Setups

Total Cost of Inventory Carrying and Setups

Economic Order Quantity

9,836.07$

9,760.00$

Copyright 1999 President and Fellows of Harvard College

$19,596.07

61

61.00

400$

1,500.00

800.00$

40%

Economic Order QuantityCalculatorANALYSIS


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Here's another way to think about the EOQ problem. This chart displays a typicalinventory scenario. Initially, 20 units of an item are placed into inventory (purchased,manufactured, etc.). As the units are removed from inventory (sold, shipped, etc.),inventory drops to 0, at which point 20 more units are placed into inventory.

The Problem

20 units may not be the optimal order level. There is a cost to keep each item in inventory(inventory holding cost), and there is a set-up cost to add new items into inventory. Ifacquiring inventory (set-up) carries a low cost, you may be better off ordering morefrequently and keeping fewer items on hand. On the other hand, if it is very expensive to

get items into inventory, but very inexpensive to keep them there, you would be better offordering more units at a time, and ordering less frequently.

The analysis sheet of this tool answers the question, "What inventory order level (q) bestbalances set-up costs against inventory holding costs?"


CalculatorCHART

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CalculatorCHART

As you can see from this chart, the two fundamental variables (inventory holding cost andset-up cost) typically have an inverse relationship relative to order size. The total cost lineis simply the sum of these two variables. The lowest point on the total cost curvecorresponds to the optimal order size. The equations on the analysis sheet of this tool

are simply calculating that low point, and presenting the corresponding order size.

Some other issues to think about include "How frequently should I place orders?" and "Atwhat inventory level should I replenish my inventory?" These questions are affected byissues including spoilage, product lifecycle, and your sales cycle.

The HBS Toolkit also contains some other Inventory Planning Tools that takesome of these other factors into account. For more information on these tools, visitthe HBS Toolkit Website.

Copyright 1999 President and Fellows of Harvard College

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ost($)perannum

Order Size (units)

inventory holding cost

set-up cost

total cost

Documents

Eo q Calculator