In today’s organizations we have a lot of acquired items and raw materials. Although most organizations have well organized methods of the flow of material, it is very difficult to find material leakages. They have a direct effect on the bottom line since it is money spend on material that was not taken into consideration during the costing phase. In this post you’ll learn:
– How to find leakages.
– How to reduce their unknown part
What is material balancing?
Material balancing compares the amount of material coming into a system/organization/suborganization against the output of the same material from the same area.
It is easy to count in the warehouse, but when we produce we create new materials from the raw materials, just like when sugar becomes candy, and now it is difficult to count the weight of the sugar since it has become candy.
How to calculate material balancing
First we need to decide on 3 things:
1. Which material we check. I will call it chosen items.
2. What is the section that we are looking at. Let’s call this section the black box. Whatever enters the black box is INPUT and whatever leaves the black box is OUTPUT of the black box. The black box can be any part of the organization, anything you want to check out.
3. The time range we are looking at. The minimal date will be the opening date and the last date will be the closing date.
Calculation
(I will explain each line later)
Opening inventory of the chosen item on the opening date
+
input of the chosen item in the given time range
–
output of the chosen item in the given time range
–
Closing inventory of the chosen item on the closing date
=
stock discrepancies (leaks)
Before I start explaining every row, let me explain something important:
Suppose we are a candy company and we want to do material balancing on sugar. The sugar that we need to count is not only the sugar that we see, but also the sugar in the candies.
For example: We produce “dietary” sweets that contain only 25% of sugar. When we have 1 ton of sweets we will have 250kg of sugar in it. So when we count the material that we investigate, we need to count the raw material and the material that is inside the WIP (work in process) and the material in the finished goods.
Lets define:
Amount of chosen item in WIP -the amount (parts/kg etc.) of the chosen part that is in the WIP at a given time. We calculate it using the BOM (bill of materials) which gives us the % of material in the WIP part and then we multiply it by the WIP amount that we have.
Amount of chosen item in FG -the amount (parts/kg etc.) of the chosen part that is in the FG at a given time. We calculate it using the BOM (bill of materials) which gives us the % of material in the FG part and then we multiply it by the FG amount that we have.
Let’s start:
Open inventory = the amount of inventory on the opening date of:
Raw material that we have in its original form + amount of chosen item in WIP + amount of chosen item in FG
Input = all purchase orders that enters the black box or other form of issuing the item to the black box.
Output = amount of chosen item in FG that left the black box + any other form that the material left the black box, such as selling the material, returning the material to the vendor, moving to warehouses that are out of the black box, etc.
Closing inventory =the inventory amount during the closing date of:
Raw material that we have in its original form + amount of chosen item in WIP +amount of chosen item in FG
Note – make sure that you don’t count the same material both in the input when you issue the item and again in the production floor inventory.
Stock discrepancies (leaks) = do the above math and the result will be the stock discrepancies that we need to investigate.
Types of stock discrepancies (leaks)
We need to explain the stock discrepancies (leaks). We can usually find them in one or more of the following options:
Scraps – material that was issued to a product that did not produce as it was supposed to and was scrapped. To calculate the amount of material that was scrapped we need to take the percentage of the chosen item in the finished product and multiply it by the number of bad units/kg.
Scrap = % in BOM X number of scrapped finished products in kg
Example: Let’s assume that 200kg of our “dietary” sweets were scrapped. The product contains 25% sugar, so we scrapped 50kg of sugar. If we send the scrapped material to the trash, we will add this to the OUTPUT section, if we put it in the inventory in order to recycle it, we should add it to the closing inventory. If we scrap the material and then recycle it, then we won’t do anything since the material was used.
Inventory transfer to “out of the black box” warehouses – make sure that there is no transaction that moves raw material or finished goods from “in the box” to “out of the box”.
Material disappearance – some materials evaporate and some are like dust – they can be blown in the wind. We need to decide on a % of evaporation from the total material we use.
Stock counts – when we count and change the inventory in the warehouse, we create a plus or minus change in the inventory. We need to take it into consideration and correct the movement. If we are missing 5kg, we must increase 5kg in the output material. And if we have a surplus, we must decrease the amount of output by the same number.
Thefts – this is the last resort. When nothing explains the discrepancies (leaks), we might have something stolen. This is of course the extreme scenario.
What can we deduct from the amount of the discrepancies?
– If we have a small amount of discrepancies then it is great (unless we deal with 24K gold :)). We can assume that some material will always get lost.
– If we have a small amount of discrepancies, then it is great (unless we deal with 24ct gold :)). We can assume that some material will always get lost.
– If we have big inventory discrepancies (leaks) and we ruled out the options above, then we will probably find the leaks in overissuing material to working orders.
For example: Let’s take our 25% sugar “dietary” sweets. When we check the product at the end of production, we can’t see the 25% of sugar. We can find the level of glucose in a laboratory. Let’s assume that our R&D wrote down the standards for this test and it looks like this: the test should be X% of glucose plus or minus 1 %. Assume that the production people know that you should add 2%-3% sugar in order to fit the given tolerance. So every time they start the production they put more sugar in, but they don’t update the BOM.
The problem above will cause the following problems:
1. The R&D/QA will reevaluate the glucose test. They will try to figure out why the test result did not reflect 25% sugar:
– It could be a different type of sugar vendor that contains less glucose
– The sugar may be less than 100% pure.
– Can the glucose test react differently to slightly different sugar, a different batch, or a different vendor?
2. If the R&D decides to add 2% more sugar to the product, they will update the BOM. So now the MRP will be much more accurate and we will not be amazed why a 60-days’ inventory lasts 55 days.
3. Now that we fixed the BOM, we will have a better costing calculation and can calculate the profit from each product that we are looking at.
Summery
Material balancing is almost an automatic tool that lets you find leaks of materials in the production flow. Many many times we spotted problematic formulas of which fixing saves us millions.
In most cases you can run material balancing every six months to look for a problem. I now work in an organization where we do it monthly.