We designed this GMROI calculator to help you calculate your gross margin return on inventory.
Are you wondering about the efficiency with which your company transforms inventory into gross profit? Then you're at the right place. GMROI is a powerful performance measurement tool you can use to determine the profitability of your inventory. This article contains information about:
- What GMROI is;
- How to calculate GMROI;
- What is a good GMROI indicator;
- How to use the GMROI indicator; and more!
What is GMROI? Gross margin return on inventory
Gross margin return on investment (GMROI) is a widely used metric for evaluating the inventory's profitability. In other words, GMROI determines how efficiently you can leverage your company's inventory for gross profit.
How can you use the GMROI index? Since companies, especially retail establishments, invest much of their capital in inventory. GMROI calculation will guide you to understand whether your inventory is profitable and decide if making changes (e.g., the price and quantity adjustment of the product) may increase your margins. Keep reading to find out what a good GMROI is.
What is a good GMROI?
In general, GMROI higher than one means that the company is making a profit on inventory. Consequently, the higher the GMROI indicator is, the better. Although, as the rule of thumb, some consider a GMROI of 3.2 a good indicator for retail stores. On the other hand, GMROI lower than one means that margins are too low. If you want to improve your inventory management, be sure to implement accounting methods such as FIFO or LIFO.
How to calculate GMROI
The GMROI formula is quite simple. To compute the indicator, you need to perform the following calculations:
GMROI = gross profit / average inventory cost
gross profitequals net sales minus the cost of sold goods.
average inventory costis the average of the beginning and ending inventory.
Let's bring an example of a hypothetical company, Alpha, with the following information:
- Gross profit: $150,000
- Average inventory cost: $50,000.
In this case,
$150,000 / $50,000 = $3 . This means that the business makes $3 in gross profits for every dollar spent on inventory. We can also say this company earns gross profits of 300% of the inventory costs.
How can I use GMROI measure?
You can use the gross margin return on investment (GMROI) measure to determine your company's inventory profitability and possibly adjust the assortment of goods or inventory that generates high margins and minimal turnover to increase the profit.
Is GMROI higher than one a good indicator?
Generally, GMROI higher than one is a good indicator. On the other hand, if your GMROI measure is lower than one, inventory is not profitable; therefore, you may need to take steps such as decreasing inventory investment, increasing customer count and average sales, etc.
What are the ways to increase GMROI indicator?
There are several ways to increase GMROI measure, some of which include:
- Raising the prices of your goods;
- Decreasing inventory investment;
- Minimizing your costs, such as raw material costs; and
- Improving your inventory turnover by keeping your inventory levels constant and increasing sales volume.
What is the difference between DIO and GMROI?
Days inventory outstanding (DIO) is a measure that indicates the duration necessary for a company to turn its inventory into sales. On the other hand, gross margin return on investment (GMROI) is a metric to determine how efficiently you can leverage your company's inventory for gross profit.