Model Answer
0 min readIntroduction
Inventory management is a critical aspect of operations management, directly impacting a company’s profitability and customer satisfaction. A key component of effective inventory control is determining the optimal order quantity and frequency. The Economic Order Quantity (EOQ) model is a classical inventory management technique used to determine the optimal order size to minimize total inventory costs. Calculating the number of orders per year, derived from the EOQ, is essential for efficient supply chain operations. This answer will detail how to determine the number of orders per year for an optimal ordering policy.
Understanding the Economic Order Quantity (EOQ) Model
The EOQ model aims to find the order quantity that minimizes the total cost of inventory, which includes holding costs (costs of storing inventory) and ordering costs (costs associated with placing and receiving an order). The fundamental principle is to balance these two opposing costs.
The EOQ Formula
The EOQ formula is:
EOQ = √(2DS / H)
Where:
- D = Annual demand in units
- S = Ordering cost per order
- H = Holding cost per unit per year
Calculating the Number of Orders Per Year
Once the EOQ is calculated, the number of orders per year can be determined by dividing the annual demand (D) by the EOQ.
Number of Orders per Year = D / EOQ
Step-by-Step Calculation
- Determine Annual Demand (D): This is the total number of units expected to be sold or used in a year.
- Determine Ordering Cost per Order (S): This includes all costs associated with placing an order, such as administrative costs, shipping, and receiving.
- Determine Holding Cost per Unit per Year (H): This includes costs like storage space, insurance, obsolescence, and capital tied up in inventory.
- Calculate EOQ: Use the formula EOQ = √(2DS / H)
- Calculate Number of Orders per Year: Divide the annual demand (D) by the EOQ.
Example
Let's assume a company has the following data:
- Annual Demand (D) = 1,000 units
- Ordering Cost per Order (S) = ₹50
- Holding Cost per Unit per Year (H) = ₹5
Step 1: Calculate EOQ
EOQ = √(2 * 1000 * 50 / 5) = √(20,000) = 141.42 units (approximately 141 units)
Step 2: Calculate Number of Orders per Year
Number of Orders per Year = 1000 / 141.42 = 7.07 orders (approximately 7 orders)
Assumptions of the EOQ Model
- Constant demand rate
- Constant lead time
- Constant ordering and holding costs
- No stockouts are allowed
- The entire order arrives at once
It’s important to note that these assumptions rarely hold true in real-world scenarios, making the EOQ model a theoretical starting point rather than a definitive solution.
Limitations and Extensions
The basic EOQ model can be extended to incorporate more realistic scenarios, such as quantity discounts, probabilistic demand, and lead time variability. Techniques like the Reorder Point (ROP) are often used in conjunction with EOQ to determine when to place an order.
Conclusion
Determining the optimal number of orders per year using the EOQ model is a fundamental aspect of inventory management. While the model relies on simplifying assumptions, it provides a valuable framework for minimizing total inventory costs. Businesses should consider the limitations of the model and adapt it to their specific circumstances, potentially incorporating more advanced inventory control techniques for improved efficiency and responsiveness. Effective inventory management remains crucial for maintaining competitiveness in today’s dynamic market.
Answer Length
This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.