The problem
In production organizations, we have plenty of raw materials. We use SKU (stock-keeping unit) numbers to distinguish between them. Even though processes in most organizations are well-organized, it is still challenging for us to know if there are any “leaks” of materials to places that were not accounted for in advance.
These “leaks” usually have a direct impact on the bottom line since they involve unplanned expenses. In this post, we will learn to identify these leaks and significantly reduce their unknown portion while achieving operational excellence.
What is Material Balance?
Material balance compares the quantity of material that entered an organization/department/area during a certain period to the quantity reported as leaving that same area. The difference between the two numbers is the leakage (and, of course, the difference between the opening inventory and the closing inventory).
This process is similar to managing inventory in a specific warehouse. In the case of a warehouse, the leaks are reflected in the discrepancies in the inventory counts.
Although it is relatively easy to calculate material balance in a warehouse, it becomes much more challenging when we look at the entire production process. This is mainly because we cannot count material when it has already been combined with other materials (If you add sugar to water, you can’t count the “number” of sugar anymore).
How to Calculate Material Balance?
To calculate material balance, you need to make three preliminary decisions:
- Select the SKU for which you want to perform the calculation. We’ll call it the “selected SKU.”
- Determine the scope of measurement. This is called the “black box.” Everything that enters the black box is considered an input, and everything that leaves it is considered an output. Everything else is either explained leaks or unexplained leaks. The scope can be the entire organization, a specific department, or any other area suspected of leaking.
- Decide on the time range you want to measure. When you input something and output something from the black box, you need to decide on the date range. The minimum date is called the opening date, and the maximum date is called the closing date.
The Calculation:
(I will explain each line separately)
Opening Inventory of the selected SKU at the opening date
+
Inputs of the selected SKU in the specified date range
–
Outputs of the selected SKU from the black box in the specified date range
–
Closing Inventory of the selected SKU at the closing date
=
Material Differences to be explained (leaks)
Before I start explaining how to calculate each line, I need to clarify something important:
Let’s assume we are a candy company and are performing material balance for sugar. The sugar we need to take into account is not only the raw sugar that we can see in the warehouse but also the sugar that is already inside the candies.
Dietary Candy Example:
For example, we produce “Dietary Sugar Candy” with 25% sugar. When we have 1 ton of the finished product, we have 250 kg of sugar. So we calculate the relative quantity of sugar in each kg/unit of the finished product times the number of units per kg. We need to calculate the quantity of material inside the finished goods and the inventory in the process.
Now, we can define two terms:
- Quantity of Material (QOM) in the Finished Goods – The relative amount of material we have in each kg/unit of the finished product multiplied by the number of units per kg.
- Quantity of Material (QOM) in the WIP – Like the QOM in the finished goods, the calculation is based on the output percentages to production orders.
Now, let’s define the components according to the above:
Opening Inventory = The opening inventory at the beginning of the period for the material we have in the warehouse + Quantity of Material in the Finished Goods + Quantity of Material in the WIP Inventory.
Inputs = All the purchase orders that entered the factory during the specified date range (If you consider a department as a black box, the inputs will be the transfer of material to the department).
Outputs = The quantity of Material in the Finished Goods that was sold and left the factory + Any other form in which the material leaves, such as selling raw material, returning to the supplier, or transferring to other warehouses not included in the black box.
Closing Inventory = The closing inventory at the end of the period for the material we have in the warehouse + Quantity of Material in the Finished Goods + Quantity of Material in the Process Inventory.
Material Differences (Leaks) = Perform the calculation as described above to get the unexplained material.
Types of leaks or material discrepancies:
The material discrepancies need to be explained. Usually, we find them in one or more of the following options:
- Scrap: Material that is rejected or recycled. If we can estimate the percentage of the material in the scrap, we can add it to the calculations as part of the process inventory.
For example, if we produce “diet candies” with 25% sugar, and during production, a batch of 200 kg of candy was spoiled, which contains an average of 50 kg of sugar. If we discarded the spoiled batch, we need to add those 50 kgs to the output (they went to the trash). If the material becomes an intermediate inventory and is intended for recycling, and it is part of the process inventory, we should add it to the opening and closing inventories accordingly. - Transfers outside the black box: Make sure you didn’t transfer material to a warehouse that was not counted or lent to another department or any other occurrence. There are many reasons material could move outside the black box, and all cases need to be accounted for.
- Material evaporation or burning: Some materials vaporize or burn during the process. There is no magic solution; we need to estimate the percentage lost during each production operation. For example, if we use a liquid that can evaporate during the production process, we can relatively easily calculate the percentage of evaporation based on specific parameters.
- Inventory counts: Inventory counts can be a nightmare. A mid-range inventory count will arbitrarily change the inventory. In this case, you need to take the overages or shortages that arose from the inventory count and add or subtract them to/from the output. Pay attention to the sign. If you are short 5 kg of sugar and corrected it, you should add 5 kg to the outputs. If you have an excess of 5 kg, you should subtract 5 kg from the outputs.
Theft: When none of the above options explain the discrepancies, you should suspect the possibility of material theft. This is, of course, an extreme case.
What can we learn from these discrepancies?
- If we have relatively small discrepancies, it’s not a problem. We have a process we can explain, and everything is fine.
- If we have very large discrepancies and have ruled out everything mentioned above, including theft, then you should look for the missing material. Most likely, you’ll find it in excessive production for finished goods to meet quality parameters. For example, taking our diet candies with 25% sugar, when we test them at the end of the production process in the laboratory, we don’t know exactly how much sugar is in them. Let’s suppose that the R&D team defined that the theoretical glucose content should be X% +/- 1%. The production team knows that to ensure the QA glucose test always passes, they should add an extra 2%-3% sugar to the formula. They don’t report it to anyone, and they do it to avoid stopping for QA reasons. So in our example, we will have a 25% in the formulas, but we actually use 27%!
Exposure to such information hopefully will lead to three main results:
A. R&D will try to understand why their theoretical glucose calculation doesn’t work. Perhaps it’s because we changed the sugar supplier, or the material isn’t pure enough? Can different types of sugar yield different values in the lab test?
B. If R&D updates the formulas accordingly (i.e., adding 2% sugar to the formula), the MRP run that determines the amount of expected materials will be much better, and we will have fewer shortages.
C. The most important result is updating the prices to reflect reality. If we thought we were earning X USD per unit and find out it’s actually only 0.97X USD, it needs to be taken into account both in the price and the contribution.
Is it complicated to build a material balance tool?
No. There’s some initial work to build the tool, but afterward, it’s almost fully automated.
conclusion
The material balance is an almost fully automated tool that is excellent for identifying process flow anomalies. These anomalies are the areas where we can improve and optimize. I have often identified these anomalies and updated the formulas, saving millions of USD.
Unfortunately, these investigations have also revealed cases of theft in our company once. However, the most critical result was identifying errors in the output, where incorrect materials were used for the formula.
As a rule of thumb, there is no need to perform a material balance more than once or twice a year for most materials. In the case of A-type items (critical raw materials) that are difficult to track (e.g., come in bulk, for example), I check them every other week to avoid surprises that lead to shortages.
I hope I explained myself properly. As always, feel free to ask me questions or comment below or via email.