Slides 5 1 calculate economic order quantity for various si

Batch Cost Example• Purchasing supplies is a common example of a Batch cost • Each purchase order issued costs the organization $250 • Demand for supplies is 200 units... Batch Cost Exam

Calculate Economic Order

Quantity

Intermediate Cost Analysis

and Management

What do you think?

Corporal O’Reilly, the supply clerk, knows that it costs the Army money to generate a purchase order To save money he proposes ordering the five years’ worth of ammunition at once

Terminal Learning Objective

• Action: Calculate Economic Order Quantity for

Various Situations

• Condition: You are training to become an ACE with

access to ICAM course handouts, readings, and

spreadsheet tools and awareness of Operational

Environment (OE)/Contemporary Operational

Environment (COE) variables and actors

• Standard: With at least 80% accuracy:

Batch Quantity Concepts

• Certain costs are fixed on a per-batch basis

• Setting up machinery to run a particular product

• Purchasing cost

• Training cost

• We call these “Batch Costs”

• More units in a batch means lower batch cost per unit

Batch cost per unit =

•  

Batch Cost Assumptions

• Annual demand for units produced in batches

is known

• Every batch is the same size

• i.e same quantity of units produced

Batch Costs

• Another way of thinking of Batch costs is:

# of Batches * Cost per Batch

-or-* Batch $Cost

•  

Batch Costs

• The full equation is:

• First divide # units demanded by # units in

batch to get # of batches, then multiply by

Batch $ Cost

•  

Batch Costs

• The full equation is:

• First divide # units demanded by # units in

batch to get # of batches, then multiply by

Batch $ Cost

•  

Batch Costs

• The full equation is:

• Or, first divide Batch $ Cost by # Units in batch

to get Batch cost per unit, then multiply by # units demanded

•  

Batch Costs

• The full equation is:

• Or, first divide Batch $ Cost by # Units in batch

to get Batch cost per unit, then multiply by # units demanded

•  

Batch Costs

• Regardless of how you look at it:

• More units in a batch mean fewer batches

• Fewer batches mean lower Batch costs

Batch Cost Example

• Purchasing supplies is a common example of a Batch cost

• Each purchase order issued costs the

organization $250

• Demand for supplies is 200 units

Batch Cost Example

• How much is purchasing cost if a separate

purchase order is issued for each unit of

supplies?

200 purchase orders * $250/ purchase order =

$50,000

• How much is purchasing cost if all 200 units

are purchased using a single purchase order?

Batch Cost Example

• How much is purchasing cost if a separate

purchase order is issued for each unit of

supplies?

200 purchase orders * = $50,000

• How much is purchasing cost if all 200 units

are purchased using a single purchase order?

1 purchase order * $250/ purchase order = $250

•  

Batch Cost Example

• How much is purchasing cost if a separate

purchase order is issued for each unit of

supplies?

200 purchase orders * = $50,000

• How much is purchasing cost if all 200 units

are purchased using a single purchase order?

1 purchase order * = $250

•  

Graph of Purchasing Cost

X-Axis = Number of units per purchase order or batch

As number of units per PO or batch increases, purchasing cost decreases

particular task in one large group?

• What else should be considered?

Learning Check

• How would you describe the graph of batch

cost?

Batch Quantity Concepts

• Certain costs increase as quantity per

purchase order increases

• Inventory ties up cash and must be stored and

maintained

• Spoilage and obsolescence can occur

• Time value of money – cash paid now is worth

more than cash paid later

Questions to Consider

• What might be the “holding costs” involved

with training all of the soldiers required for a particular task in one large group or “batch”?

Holding Cost Assumptions

• Annual Holding Cost is linear or variable on a per-unit basis

• Units produced or purchased in batches are consumed or sold uniformly throughout the period

Holding Costs

• Holding cost =

$Holding Cost/Unit * Avg #Units in Inventory

• Average #Units in Inventory =

#Units per Purchase Order/2

• Assumes Inventory is consumed uniformly

throughout the year

Graph of Inventory Assumption

Graph of Inventory Assumption

Units Consumed or Sold uniformly until all Inventory is gone

25.00

Graph of Inventory Assumption

Average Inventory is 50/2 or 25 Units

Average Inventory

25.00

Holding Cost Example

• Annual holding cost for supplies is $50 per unit

• What is holding cost if each unit of supplies is

purchased on its own purchase order?

• Average inventory = 1 unit/2 or ½ unit

• ½ unit * $50/unit = $25

• What is holding cost if all 200 units of supplies are purchased on one purchase order?

Holding Cost Example

• Annual holding cost for supplies is $50 per unit

• What is holding cost if each unit of supplies is

purchased on its own purchase order?

• Average inventory = 1 unit/2 or ½ unit

Holding Cost Example

• Annual holding cost for supplies is $50 per unit

• What is holding cost if each unit of supplies is

purchased on its own purchase order?

• Average inventory = 1 unit/2 or ½ unit

• ½ unit * $50/unit = $25

• What is holding cost if all 200 units of supplies are purchased on one purchase order?

Graph of Holding Cost

X-Axis = Number of units per purchase order

As number of units per purchase order increases, holding cost increases

When quantity per purchase order is 10

Average Inventory = 5 and holding cost is $250

When quantity per purchase order is 10

Average Inventory = 5 and holding cost is $250

When quantity per purchase order is 100

Average Inventory = 50 and purchasing cost is $2,500

When quantity per purchase order is 100

Average Inventory = 50 and purchasing cost is $2,500

Optimizing Order Quantity

• Total Costs Related to Order Quantity =

Purchasing Cost + Holding Cost

• What is Total Cost when Quantity per order is

Optimizing Order Quantity

• Total Costs Related to Order Quantity =

Purchasing Cost + Holding Cost

• What is Total Cost when Quantity per order is

10 units?

5000 + 250 = 5250

• What is Total Cost when Quantity per order is

Optimizing Order Quantity

• Total Costs Related to Order Quantity =

Purchasing Cost + Holding Cost

• What is Total Cost when Quantity per order is

Graph of Total Costs

Total Cost is minimized where Purchasing Cost = Holding Cost

Total Cost is minimized where Purchasing Cost = Holding Cost

Optimizing Order Quantity

• Total Cost is minimized at the order quantity where Holding Cost = Purchasing Cost

• Computation of this “Indifference Point”

requires calculus beyond the scope of this

course

Optimizing Order Quantity

• The relationship is well-documented and is

captured in the “Economic Order Quantity”

Calculating EOQ

• Demand is 200 units

• Purchasing Cost is $250 per Order

• Holding Cost is $50 per Unit

EOQ = EOQ = = approx 45 units

•  

Practical Exercise

Batch Quantity Spreadsheet

Enter batch cost, holding cost, and demand into the spreadsheet

to generate the graph of total cost

Enter batch cost, holding cost, and demand into the spreadsheet

to generate the graph of total cost

Practical Exercise