Since 60% to 80% of a typical retailer’s total assets are in inventory, it is essential that retailers know how their inventory investment is performing. The GMROI calculation is the tool for the job. It’s one of the best tools for measuring and managing the productivity of your inventory investment. In our view, it is the No. 1 measure of inventory productivity.
It’s fast and easy to calculate, but best of all, it provides powerful insights specifically for retailers.
Calculating GMROI
GMROI — gross margin return on inventory investment — indicates how much gross margin (also called gross profit) you get back for each dollar invested in inventory. Through careful analysis, you can see which lines, departments or categories are the most rewarding for your inventory investment — and you can see the ones that are least productive.
Here’s the formula for calculating GMROI:
GMROI = Gross Margin in dollars divided by Average Inventory at Cost
For example, consider this merchandise category:
– Annual sales = $130,000
– Gross Margin = $63,700 (49%)
– Average Inventory at Cost = $40,625
– GMROI = $63,700 / $40,625 = $1.57
This means the retailer is getting $1.57 in gross margin back for every $1 invested in inventory in this category for the year.
Prefer a “down ‘n’ dirty” GMROI formula?
Just find the gross margin dollars of a department for one full week. Then multiply it by 52 weeks and complete the calculation by dividing your current on-hand inventory at cost into the “annualized” figure for gross margin dollars. With many of today’s point-of-sale systems, this is quick to calculate and useful for comparing departments on the fly.
Compare and Contrast
Calculating GMROI becomes really powerful once you are able to compare this category to the others in your store and/or to the previous year.
Consider this example:
Which of these four departments is the most productive?
Department A has the highest sales (Gotta love a great top line!).
Departments B and C have similar sales, but C has the highest margin.
Department D has the lowest sales and the second-lowest gross margin.
So … which department is the “best” for this retailer?
Careful. That can be answered only after we calculate the GMROI.
Here are the GMROI calculations for each of these four departments.
Although many people will overlook Department D because it has the lowest sales and margin, it is the productivity winner. It has the highest GMROI. Its lower margin is offset by its higher inventory turns.
It’s important to keep in mind that sales and margin alone don’t really tell the whole story.
Dynamic Management Tool
You can calculate GMROI by departments, as above, or by categories, seasons, vendors, regions or individual stores.
The GMROI calculation provides good insights into the productivity of your inventory investment. You will find a new awareness when each product line is weighed in terms of combined gross margin profitability and turnover.
GMROI is a powerful tool for retailers, allowing them to examine and analyze results to date, as well as playing “what if?” with future plans.
GMROI analysis may challenge your notion of which products you should carry, or even which vendors you should buy from. A product with a GMROI well below the others should be challenged. Ask questions like these:
– Do I devote too much inventory to this category?
– Could my vendor ship to me more frequently?
– Is that “special buy” really a wise investment, given how much I have to buy up front?
– How much can I cut prices to increase sales without lowering my GMROI in a category?
The merchandise retailers sell doesn’t change much each year, even in cannabis. Sure, there are fads and technological advances, but retailers must still sell to meet customer needs and desires, making it essential that every dollar invested in inventory be as productive as possible at producing gross margin dollars. The GMROI calculation helps retailers quickly see where to get more bang for the buck.
Patricia M. Johnson and Richard F. Outcalt are certified management consultants and co-founders of The Retail Owners Institute. They are strategists for retailers, workshop presenters and publishers of a free and popular newsletter for store owners and managers. Sign up for The ROI News for free at RetailOwner.com. They can be reached at 206-623-3973.