One key performance indicator for a successful retail business is Gross Margin Return on Investment (GMROI). It provides valuable insight into merchandise choices and profitability. It also indicates how well inventory is managed. When most of a retailer’s assets are tied up in inventory, they need to know how profitable it is. Any slow performers can tie up cash and increase carrying costs.
Understanding the Numbers
The GMROI focuses on three things: inventory costs, pricing, and turnover. To begin, you need to calculate the gross margin by taking the total revenue over a period of time and subtracting the cost of goods sold (COGS).
The period of time can vary from weeks to months or a full year. In order to be consistent, you’ll need to choose the one that best fits your business, then use it for all of your calculations. For example, if Company Z’s revenue was $1 million last year and their COGS was $500 thousand, then their gross margin was 50%.
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The next step is to calculate the average inventory. This measures the value of your inventory during two or more specific periods. You simply add the cost of your current inventory with the cost of your inventory and divide by the number of periods:
A good example of this would be Company Z’s current inventory is $50 thousand and last month’s inventory was $75 thousand, then the average would be $62,500 over two months. This calculation can also be used to focus on a particular product or category of products.
Once you have your average inventory, you can calculate GMROI. We found the formula below to be the simplest to use:
Let’s use Company Z as our example. They had a gross margin of $500 thousand for the year and an average inventory of $62,500. Their GMROI would be 800%. Any number below 100% means that you are losing money.
GMROI is also a powerful tool for merchandise planning. It can be used as a measure of historical performance to project potential returns on individual products or product categories. This calculation can also be used for short-term planning by using weeks instead of months, giving you an idea of how much you might sell, which allows you to set targets. If your sales don’t meet your expectations, then you can make quick and decisive actions to prevent losses and maintain profitability.