Calculate Economic Order Quantity © Dale R. Geiger 20111

What do you think? Corporal O’Reilly, the supply clerk, knows that it costs the Army money to generate a purchase order. To save money he proposes ordering the five years’ worth of ammunition at once. © Dale R. Geiger 20112

Terminal Learning Objective Action: Calculate Economic Order Quantity For Various Situations Condition: You are a cost advisor technician with access to all regulations/course handouts, and awareness of Operational Environment (OE)/Contemporary Operational Environment (COE) variables and actors. Standard: With at least 80% accuracy: 1.Describe the concept of economic order quantity 2.Identify the key variables in the EOQ calculation © Dale R. Geiger 20113

Batch Quantity Concepts © Dale R. Geiger 20114

Batch Cost Assumptions Annual demand for units produced in batches is known Every batch is the same size i.e. same quantity of units produced © Dale R. Geiger 20115

Batch Costs Batch Costs © Dale R. Geiger 20116

Batch Costs Batch Costs © Dale R. Geiger 20117

Batch Costs Batch Costs © Dale R. Geiger 20118

Batch Costs Batch Costs © Dale R. Geiger 20119

Batch Costs Batch Costs © Dale R. Geiger

Batch Costs Batch Costs © Dale R. Geiger

Batch Costs Batch Costs Regardless of how you look at it: More units in a batch mean fewer batches Fewer batches mean lower Batch costs © Dale R. Geiger

Check on Learning How does batch cost per unit change as batch size increases? What are the key assumptions in batch quantity tradeoffs? © Dale R. Geiger

Batch Cost Example Purchasing supplies is a common example of a Batch cost Each purchase order issued costs the organization $250 Demand for supplies is 200 units © Dale R. Geiger

Batch Cost Example How much is purchasing cost if a separate purchase order is issued for each unit of supplies? 200 purchase orders * $250/ purchase order = $50,000 How much is purchasing cost if all 200 units are purchased using a single purchase order? 1 purchase order * $250/ purchase order = $250 © Dale R. Geiger

Batch Cost Example © Dale R. Geiger

Batch Cost Example © Dale R. Geiger

Graph of Purchasing Cost $ X-Axis = Number of units per purchase order or batch As number of units per PO or batch increases, purchasing cost decreases © Dale R. Geiger

Questions to Consider Using only this information for your decision, how many units should be ordered per purchase order? Similarly, what savings might be achieved by training all of the soldiers needed for a particular task in one large group? What else should be considered? © Dale R. Geiger

Check on Learning How would you describe the graph of batch cost? © Dale R. Geiger

Batch Quantity Concepts Certain costs increase as quantity per purchase order increases Inventory ties up cash and must be stored and maintained Spoilage and obsolescence can occur Time value of money – cash paid now is worth more than cash paid later “Just in Time” ordering minimizes these “Holding Costs” © Dale R. Geiger

Questions to Consider What might be the “holding costs” involved with training all of the soldiers required for a particular task in one large group or “batch”? © Dale R. Geiger

Holding Cost Assumptions Annual Holding Cost is linear or variable on a per-unit basis Units produced or purchased in batches are consumed or sold uniformly throughout the period © Dale R. Geiger

Holding Costs Holding cost = $Holding Cost/Unit * Avg. #Units in Inventory Average #Units in Inventory = #Units per Purchase Order/2 Assumes Inventory is consumed uniformly throughout the year © Dale R. Geiger

Graph of Inventory Assumption 50 Units produced or purchased per batch X axis represents time © Dale R. Geiger

Graph of Inventory Assumption Units Consumed or Sold uniformly until all Inventory is gone © Dale R. Geiger

Graph of Inventory Assumption Average Inventory is 50/2 or 25 Units X axis represents time © Dale R. Geiger

Check on Learning What are the underlying assumptions related to holding costs? How is average inventory calculated? © Dale R. Geiger

Holding Cost Example Annual holding cost for supplies is $50 per unit What is holding cost if each unit of supplies is purchased on its own purchase order? Average inventory = 1 unit/2 or ½ unit ½ unit * $50/unit = $25 What is holding cost if all 200 units of supplies are purchased on one purchase order? Average inventory = 200 units/ 2 or 100 units 100 units * $50/unit = $5,000 © Dale R. Geiger

Holding Cost Example Annual holding cost for supplies is $50 per unit What is holding cost if each unit of supplies is purchased on its own purchase order? Average inventory = 1 unit/2 or ½ unit ½ unit * $50/unit = $25 What is holding cost if all 200 units of supplies are purchased on one purchase order? Average inventory = 200 units/ 2 or 100 units 100 units * $50/unit = $5,000 © Dale R. Geiger

Holding Cost Example Annual holding cost for supplies is $50 per unit What is holding cost if each unit of supplies is purchased on its own purchase order? Average inventory = 1 unit/2 or ½ unit ½ unit * $50/unit = $25 What is holding cost if all 200 units of supplies are purchased on one purchase order? Average inventory = 200 units/ 2 or 100 units 100 units * $50/unit = $5,000 © Dale R. Geiger

Graph of Holding Cost $ X-Axis = Number of units per purchase order As number of units per purchase order increases, holding cost increases When quantity per purchase order is 10 Average Inventory = 5 and holding cost is $250 When quantity per purchase order is 10 Average Inventory = 5 and holding cost is $250 When quantity per purchase order is 100 Average Inventory = 50 and purchasing cost is $2,500 When quantity per purchase order is 100 Average Inventory = 50 and purchasing cost is $2,500 © Dale R. Geiger

Check on Learning How does holding cost change as batch quantity changes? How is holding cost represented on the graph? © Dale R. Geiger

Optimizing Order Quantity Total Costs Related to Order Quantity = Purchasing Cost + Holding Cost What is Total Cost when Quantity per order is 10 units? = 5250 What is Total Cost when Quantity per order is 100 units? = 3000 © Dale R. Geiger

Optimizing Order Quantity Total Costs Related to Order Quantity = Purchasing Cost + Holding Cost What is Total Cost when Quantity per order is 10 units? = 5250 What is Total Cost when Quantity per order is 100 units? = 3000 © Dale R. Geiger

Optimizing Order Quantity Total Costs Related to Order Quantity = Purchasing Cost + Holding Cost What is Total Cost when Quantity per order is 10 units? = 5250 What is Total Cost when Quantity per order is 100 units? = 3000 © Dale R. Geiger

Graph of Total Costs ≈45X-Axis = Order quantity in units Total Cost is minimized where Purchasing Cost = Holding Cost Total Cost is minimized where Purchasing Cost = Holding Cost © Dale R. Geiger

Optimizing Order Quantity Total Cost is minimized at the order quantity where Holding Cost = Purchasing Cost Computation of this “Indifference Point” requires calculus beyond the scope of this course © Dale R. Geiger

Optimizing Order Quantity © Dale R. Geiger

Calculating EOQ © Dale R. Geiger

Check on Learning What are the three variables used in the Economic Order Quantity formula? How will EOQ change if holding cost per unit increases while all other variables remain the same? © Dale R. Geiger

Practical Exercise © Dale R. Geiger

Batch Quantity Spreadsheet © Dale R. Geiger Enter batch cost, holding cost, and demand into the spreadsheet to generate the graph of total cost

Practical Exercise © Dale R. Geiger