ECONOMIC ORDER QUANTITY
The above is a standard diagram of INVENTORY CONTROL and EOQ called ECONOMIC ORDER QUANTITY and such diagrams are discussed at various levels.
The concept of EOQ is one of the basis on which Inventory Control is studied and carried out in practical situations and the many kinds of Inventory models that have come up of-late do have their basis on concepts like this.
Inventory planning is influenced by two kinds of conflicting forces..the Carrying cost and the Ordering cost.The carrying cost would be the rent you would pay for a store house and add to it labor costs and material handling costs......Ordering cost also called procurement cost is the cost of bringing an item into a ware-house and would involve transport cost and associated labor and any transis warehousing and communication costs.
If procurement costs are high then the EOQ will be high and if Carrying costs are low EOQ will be high..and EOQ is a trade-off in terms of volume ordered at any point in time which would keep the cumulative of these costs low.
Consider the following steps that are used to derive an expression for EOQ;
Cc is carrying cost per item per year
Cp is procurement cost per order
A is total demand per year
Q is EOQ Economic Order Quantity (half of which is Average Inventory)
TOTAL INVENTORY COSTS = TOTAL CARRYING COST + TOTAL PROCUREMENT COST
TOTAL CARRYING COST = AVERAGE INVENTORY X Cc
TOTAL PROCUREMENT COST = ORDERS PER YEAR X Cp
TOTAL INVENTORY COSTS = Q/2 X Cc + A/Q X Cp
AT MINIMUM Q THE DIFFERENTIATION OF THE ABOVE EXPRESSION with respect to Q WILL BE EQUATED TO ZERO.
THEREBY WE GET EOQ = SQRT (2 A Cp / Cc)