Why Accountants came up with the Economic Order Quantity (EOQ) and Reorder Point (ROP) Inventory

Control Systems in Retail and Manufacturing?

Most firms involved in manufacturing are into inventory control. The main idea is that you want to have
enough inventory on hand to keep the line working but at the same time not to have too much inventory
on hand because it can be costly. Firms need to work out some sort Minimum necessary so they can keep
the assembly line going without closing it down and lose money but at the same time not have too much
inventory on stock to reduce their cash position. Finding a happy medium is what EOQ and ROP is all about.

Here are 3 main items to consider in figuring out EOQ and ROP planning which are:


1. EOQ or Economic Order Quantity is both an algebraic and it has a graphical solution. You
will see how it works watching a few of the videos.
2. Safety ~ Retailers like Walmart when a product on a shelf goes low, to reorder another
product to replace it. Also, in manufacturing there is a point where there is always enough
inventory on stock to keep the assembly line running. If the assembly line goes down not
only does the work stop but there are laborers either out of work or not doing their
assembly work they are paid to do other jobs not pertinent to production or are laid off,
then the firm is losing money.
3. ROP Re-order Point starts once the Safety is breached also depending on the days it takes
for the delivery to be met. The firm must order the part to keep inventory on the shelf or
the assembly line moving.

Here are two examples that I found on Google to help you quantify both (EOQ) and (ROP) that offers some
calculations for you to see as to how to calculate EOQ and find ROP. I also added some more videos below.
Dr. Steve

“The EOQ reorder point is a contraction of the term economic order quantity reorder point. It is a
formula used to derive that number of units of inventory to order that represents the lowest
possible total cost to the ordering entity. It essentially creates a least-cost balance between the cost of
ordering inventory and the cost of holding inventory. The EOQ reorder point is derived from this
formula:

The inputs to the model are noted within the formula.

For example, ABC International uses 100,000 pounds of aluminum ingots per year, and the cost to
place each order is $15. The carrying cost for one pound of aluminum ingots is $5 per year. The EOQ
reorder point, based on this information, is the square root of:

(2 x 100,000 x $15) ÷ $5

= EOQ reorder point of 775 units

It is useful to test variations on the ordering cost and annual carrying cost to see how they impact the
EOQ. It is possible that driving down the annual carrying cost of inventory can significantly alter the
EOQ reorder point. A key factor in this analysis is determining which carrying costs actually vary with
inventory volumes, and which are unrelated fixed costs. If they are unrelated, do not include them in
the denominator of this calculation.

The EOQ reordering system is not used in "pull" manufacturing systems, where components are
ordered from suppliers only as needed and in the quantities needed; thus, a pull system tends to order
fewer components than an EOQ reordering formula would indicate as optimal.”

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How to Determine a Re-order Point

“A reorder point is the unit quantity on hand that triggers the purchase of a predetermined
amount of replenishment inventory. If the purchasing process and supplier fulfillment work as
planned, the reorder point should result in the replenishment inventory arriving just as the last of
the on-hand inventory is used up. The result is no interruption in production and fulfillment
activities, while minimizing the total amount of inventory on hand.

The reorder point can be different for every item of inventory, since every item may have a
different usage rate, and may require differing amounts of time to receive a replenishment
delivery from a supplier. For example, a company can elect to buy the same part from two
different suppliers; if one supplier requires one day to deliver an order and the other supplier
requires three days, then the company's reorder point for the first supplier would be when there is
one day's supply left on hand, or three days' supply for the second supplier.

The basic formula for the reorder point is to multiply the average daily usage rate for an inventory
item by the lead time in days to replenish it. For example, ABC International uses an average of 25
units of its green widget every day, and the number of days it takes for the supplier to replenish
inventory is four days. Therefore, ABC should set the reorder point for the green widget at 100
units. When the inventory balance declines to 100 units, ABC places an order, and the new units
should arrive four days later, just as the last of the on-hand widgets are being used up.

However, this formula for the reorder point is only based on average usage; in reality, demand
may spike above or decline below the average level, so there may still be some inventory on hand
when the replenishment order arrives, or there may have been a stockout condition for several
days that has interfered with production or sales. To guard against the latter condition, a company
may alter the reorder formula to add a safety stock, so that the formula becomes:

(Average daily usage rate x Lead time) + Safety stock

This formula alteration means that replenishment stock will be ordered sooner, which greatly
reduces the risk that there will be a stockout condition. However, it also means that a company
will have a larger investment in its on-hand inventory, so there is a trade-off between always
having available inventory and funding a larger inventory asset.

Please note that the reorder point only indicates when to place a replenishment order; it does not
calculate the amount of items that should be ordered (which is addressed by the economic order
quantity formula). Better yet, consider using a just-in-time or material requirements planning
system, which only order new inventory when there is a specific, identified reason for doing so.”

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“How to calculate reorder point?

 Calculate your lead time demand in days.

 Calculate your safety stock in days.

 Sum your lead time demand and your safety stock to determine your Reorder Point.

To understand the math behind our reorder point calculator, let’s break this formula down.

You’ll need to know the lead time demand, because that’s how long you’ll have to wait before
new stock arrives - you’ll want to have enough to satisfy your customers while you wait!
And you’ll need to know your safety stock, because that’ll protect you against any unexpected
occurrences. Add your lead time demand to your safety stock… and voila! Once your stock levels
hit the total, it’s time to place a new order to replenish your supply.”

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ROP Re-Order Point Formula = Lead Time Demand + Safety Stock

Use these YouTube Videos to calculate EOQ and ROP using Excel
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For those who enjoy lectures Here are some Professor

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Module 4 Assignment Questions: 6-20, 6-22, 6-24, 6-30.