Previous articles in the series “Between theory and practice of inventory management” published by the author in LOGISTYKA (5/2008, 6/2008, 1/2009, 2/2009, 6/2010 and 1/2011) referred to issues related to shaping the appropriate level of safety stock. This article is devoted to the issue of optimizing cycle (rotating) stock by determining the so-called economic order quantity. The classic formula used to calculate it was presented almost 100 years ago, but despite the passage of time, it remains one of the most important in material flow management. This is not changed by the fact that the use of this formula is subject to numerous limitations, and since its introduction, a number of its modifications have been created.
Economic order quantity – general assumptions
The use of the economic order quantity (EOQ) allows for the minimization of total ordering costs (renewing, replenishing stocks) and the costs of maintaining the cyclical part of the stock (total cycle stock cost – TCSC) in the considered period (for example, one year).
TCSC = FCRSC + VCRSC + FCHSC + VCHSC
where:
FCRSC – fixed cost of replenishing cycle stock. These are costs independent of the number of deliveries in the considered period. Therefore, they also do not depend on the size of a single delivery. These are, for example:
– procurement (purchasing) department costs, including salaries and related charges, building usage costs, electricity, water consumption costs, etc.
– cost of maintaining own vehicle fleet used in delivery fulfillment.
FCRSC = const
VCRSC – variable cost of replenishing cycle stock. These are costs that, in the considered period, depend on the number of deliveries (they are therefore dependent on the size of a single delivery). These are, for example:
– costs of placing orders (including communication costs with the supplier, concerning each order)
– variable transport costs (dependent on the number of deliveries)
– insurance costs
– costs related to customs handling fees
– special costs of receiving deliveries (for example, laboratory tests of each delivery)
– expected (average) stockout costs related to one replenishment cycle (dependent on the probability of meeting demand in the cycle).
FCHSC – fixed cost of holding cycle stock. These are costs independent of the stock size, for example:
– depreciation of warehouse buildings
– depreciation of warehouse equipment
– cost of warehouse personnel.
FCHSC = const
VCHSC – variable cost of holding cycle stock. These costs depend on the stock size. These are, for example:
– additional (special) costs of used warehouse space (for stock)
– costs of natural losses and warehouse shortages
– costs of theft and other losses
– cost of stock insurance
– cost of frozen capital (credit costs or lost investment benefits from equity).
The article comes from the magazine “Logistyka” 2/2011.