What is GMROI and How Do We Apply It?

GMROI stands for Gross Margin Return On Inventory. Or sometimes you’ll see it called GMROII – Gross Margin Return on Inventory Investment.

By calculating your GMROI you can answer the question, “For every dollar I invest in inventory, how many dollars am I getting back?”

Before you understand how to calculate GMROI, you first have to understand two other important retail math calculations:

1) Calculate Gross Margin

Gross Margin $ = Sales – Cost of Goods Sold

In the following example if you sell $32,826 of merchandise with a cost of goods sold of $14,739 your gross margin in dollars is $18,087.

$32,826 sales – $14,739 COGS = $18,087 Gross Margin $

Note: Cost of goods sold commonly includes freight charges, not just the cost price of the merchandise.

2) Calculate Average Inventory on Hand

Average Inventory = Sum of Beginning of Month Inventory $ / Number of Months

This equation will tell you how much inventory you own ON AVERAGE over a given period of time. Average inventory is generally calculated for a year, or 12 month period, but could be calculated for any period of time – a season, a quarter, a month.

If you are looking at a shorter time period like a month, you might take the sum of the inventory on hand at the beginning of every DAY (instead of the beginning of every month) and divide by the number of days in the month. Or for a quarter, take the beginning of the WEEK inventory on hand $ divided by the number of weeks in the quarter.

A good POS system will probably be able to instantaneously give you a very accurate average inventory report for any given period.

In the following example, over 12 months the average inventory on-hand is $45,800. You can see that some months are higher, some are lower, but ON AVERAGE this store carries $45,800 of merchandise at any given time.

($19,000 + $27,000 + $34,000 + $39,000 + $54,000 + $61,000 + $66,000 + $58,000 + $29,000 + $22,000 + $53,000 + $88,000) / 12 mos. = $45,800

Average inventory is $45,800.

Note: average inventory can be calculated for either the cost value or the retail value of your inventory.

3) Calculate GMROI

GMROI = Gross Margin $ / Average Inventory $ @ Cost
So for any given period of time (usually a year or a season) you take the Gross Margin $ from calculation #1 above divided by your average inventory at cost from calculation #2 above.

$245,000 GM$ / $110,000 Avg. Inv. @ cost = 2.23

In this example the equation tells you that for every $1.00 you invest in inventory, you get back $2.23.

While the number in and of itself is useful, using GMROI to compare departments or vendors to each other is where the real power lies.

For example, if one of your departments gives you a GMROI of $2.23 but another only gives you a GMROI of $1.85, where are you going to invest more of your dollars? On which department are you going to focus your time, attention, floor space, or best merchandising efforts? The one with the bigger GMROI.

Doing this calculation for different vendors can be useful when you are going into a meeting to negotiate pricing, freight allowances, terms, and so on. You can easily and objectively explain your decision making criteria to your vendor. If two vendors sell similar merchandise and one is giving you lower GMROI you can show your numbers and ask for improvements.
Have fun working with your GMROI!

 

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By POS Highway Staff | September 20th, 2023 | Retail Operations Management, Supply Chain Management | 0 Comments

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