Economic Order Quantity
This represents the normal quantity to be placed on order when the stock has reached its re-order level. Re-ordering quantity is to be fixed taking into account the maximum and minimum stock levels. The quantity ordered must be that which, when added to the minimum stock, will not exceed the maximum stock to be carried at any point of time. The following factors govern the re-ordering quantity.
- Average consumption
- Cost of pacing order
- Cost of storage
- Interest on capital etc.,
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.
ii) Interest on capital invested (the opportunity cost of the capital blocked up) and
iii) Cost of placing the order each time.
Economic order quantity or economic lot size (if it relates to production) refers to the number ordered in a single purchase or number of units should be manufactured in a single run so that the total costs-ordering or set up costs and inventory carrying costs are at the minimum level. In other words, it is the quantity that should be ordered at one time so as to minimize the total of
Cost of placing orders and receiving the goods, and
Cost of storing the goods as well as interest on the capital invested.
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