Economic Order Quantity (EOQ) is a formula used in inventory management to determine the optimal quantity of goods that should be ordered at one time.
It helps to strike a balance between carrying costs and ordering costs, aiming to minimize total inventory costs.
The assumptions underlying the EOQ model
Demand is known: The EOQ assumes that the demand for the product is constant and accurately known during the entire planning period.
Constant lead time: The lead time, which refers to the time between placing an order and receiving it, is assumed to be constant and consistent for each order.
No stockouts or backorders: The EOQ assumes that there will be no stockouts or backorders during the planning period. This assumption implies that replenishment will always occur before running out of stock.
Instantaneous delivery: It is assumed that once an order is placed, it will be delivered instantaneously without any delays.
Fixed purchase cost: The cost of placing an order, usually including administrative expenses such as processing paperwork and transportation costs, remains constant regardless of the order quantity.
Constant holding cost: The holding cost, which includes expenses such as warehousing, insurance, and obsolescence, is assumed to remain constant per unit over time.
No quantity discounts: The EOQ does not consider any discounts provided by suppliers based on larger order quantities.
Single product focus: The EOQ model assumes that only one item is managed at a time, assuming no interactions with other products or constraints regarding available space or production capacity.
It’s important to note that while these assumptions simplify the calculations and implementation of the EOQ model, they may not always hold true in real-world scenarios. Therefore, adjustments and modifications may be necessary based on specific business situations and requirements.