ITLS6002 Chap.1 Inventory Costs, EOQ and Reorder Points
Inventory Costs, EOQ and Reorder Points
Inventory decisions begin by separating acquisition, ordering, holding and shortage costs, because only costs that change with the decision belong in the optimisation. The economic order quantity balances annual ordering and holding costs under steady demand, while the reorder point answers a different question: when to release the replenishment order.
The sawtooth profile links order quantity to average cycle stock and makes units a useful error check. This chapter also covers sensitivity, total relevant cost and the practical limits of the basic model, including the assumptions of constant demand, instantaneous replenishment and no stockouts.
A robust solution converts the carrying percentage to dollars per unit-year, keeps demand on the same annual basis, and verifies the result by comparing annual ordering and holding costs. Operational restrictions such as carton size are handled after the unconstrained calculation by testing neighbouring feasible quantities.
Lead time belongs in the trigger calculation rather than the EOQ expression, so a changed lead time can move the reorder point without changing the replenishment size. The final policy must state both decisions in words and identify the inventory position used to release an order.
What this chapter covers
- 01
Inventory cost classification
- 02
Economic order quantity derivation
- 03
Cycle stock and sawtooth profiles
- 04
Reorder point timing
- 05
Total relevant cost comparison
- 06
Assumptions and sensitivity checks
Worked example · free
EOQ and reorder point for a steady-demand item
- 2Compute EOQ as sqrt(2 x 9,600 x 75 / 6) = 489.90 units.
- 2Round to a feasible 490 units and check that ordering and holding costs are approximately balanced.
- 2Weekly demand is 9,600 / 48 = 200 units, so the deterministic reorder point is 200 x 3 = 600 units.
- 2Keep the decisions distinct: 490 units is how much to order, while 600 units is the inventory position that triggers the order.
Key terms
- Ordering Cost
- The fixed administrative or setup cost incurred each time an order is placed.
- Holding Cost
- The annual cost of financing, storing and risking one unit of inventory.
- Cycle Stock
- Inventory created by ordering or producing in batches rather than continuously.
- Inventory Position
- On-hand inventory plus scheduled receipts minus backorders, used for reorder decisions.
Inventory Costs, EOQ and Reorder Points FAQ
Why are purchase costs often omitted from the basic EOQ objective?
If the unit price is constant, annual purchase cost does not change with order quantity, so it cannot change the optimum. Purchase cost must return to the comparison when quantity discounts or other price changes make it decision-relevant.
Should EOQ be rounded before calculating cost?
Report the mathematical value, then test nearby feasible quantities or packaging multiples. The total-cost curve is usually flat near its minimum, so a practical rounded order can be nearly optimal while being easier to execute.
What is the most common EOQ versus reorder-point mistake?
Students often treat both as stock quantities with the same purpose. EOQ determines replenishment size; the reorder point determines release timing. State the units and business meaning beside each computed result.
How can the EOQ result be checked without repeating the whole calculation?
At the unconstrained EOQ, annual ordering cost and annual cycle-stock holding cost should be approximately equal. A large gap signals inconsistent time units, an incorrect carrying-cost conversion or misplaced parentheses. Equality is not required after a carton, capacity or discount constraint changes the feasible quantity.
Which inventory measure should be compared with the reorder point?
Use inventory position rather than only physical stock on hand. Inventory position includes scheduled receipts and subtracts backorders, preventing a duplicate order when replenishment is already in transit. State the convention used if the case defines inventory position differently.
Does a longer lead time always increase the recommended order quantity?
Not in the basic EOQ model. A longer certain lead time raises the reorder point because more demand must be covered before receipt, but it does not change EOQ unless demand, ordering cost or annual holding cost also changes.
Exam move
Start each problem with a symbol-and-unit table. Classify every cost as fixed per order, annual per unit, purchase-related or shortage-related before selecting a formula. Draw a sawtooth and label the order quantity, average cycle stock and lead-time demand. After computing EOQ, verify that annual ordering and holding costs are close, then explain whether rounding, capacity or price breaks would change the recommendation.
Rework one example by changing only lead time and another by changing only ordering cost; the contrast shows which policy component should move. Build a three-row candidate table whenever packaging constrains the result, keeping purchase cost separate unless price varies. For retrieval practice, cover the formula and reconstruct it from the falling ordering-cost term and rising holding-cost term.
Finish each response with one sentence naming the order size, the trigger, the units and the assumption most likely to fail in practice.
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