One important question before the materials department, when placing an order before the supplier, is to select an optimum order size which is also called economic order quantity. Economic order quantity(EOQ) is the optimum ordering quantity i.e. the quantity for which cost of holding plus the cost of purchasing is the minimum. The factors that affect EOQ are material carrying charges and the ordering cost associated with placing the order. The basic aim behind setting of EOQ is to minimise both the costs. The material carrying costs include interest on the capital invested in stock of materials, rent of the storage space occupied, salary and wages of the store keeping department,insurance charges, any loss due to pilferage and deterioration of materials, taxes on materials etc. Ordering cost includes rent for the space occupied by purchase department, postage, stationery and other consumables, telephone charges of the purchase department, depreciation on the assets of the department, travelling expenses and cost of inspection of the materials if any.
Economic order quantity is calculated using the following formula:
Here U=annual consumption of materials in units
P= cost of placing an order
S=annual storage cost of one unit