Question

1. A common method that we use to determine the appropriate inventory levels is the economic order quantity (EOQ) model. Explain what this model is.

Answer 1

The EOQ ensures that the right quantity of inventory is ordered so that the company does not have to order the inventory frequently. It is an inventory management tool, to ensure that the right level of inventory is ordered. The EOQ gives an indication weather the current quantity of stocks ordered is correct or not.

The formula for the EOQ is :

EOQ = root over of ( 2 * S *D ) / H

Where,

S= setup costs

D= demand rate

H = holding costs

The setup costs is all the costs associated with handling delivery ,packaging and shipping.

Demand rate is the amount of inventory a company sells each year.

Holding costs is the costs of the additional inventory. This costs include warehousing costs, material handling and additional inventory.

EOG includes the costs of purchasing an order, costs to store the merchandise, this model considers the time for reordering.