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As a retailer, how do you measure your business’s ability to turn its inventory into profit? One KPI that can help you do this is gross margin return on investment or GMROI.
It’s one of the most critical KPIs used by retailers, helping them gauge how much profit they generate from each dollar invested in inventory.
In this KPI glossary entry, we’ll provide a clear definition of this KPI, discuss why it’s important and explain the gross margin return on inventory formula.
We’ll also show you how to perform a GMROI calculation with step-by-step instructions.
Selling your inventory of course doesn’t always mean you’re making a profit.
You also need to factor in the cost of purchasing the inventory in the first place, as well as the cost of transporting, storing and preparing inventory.
The gross margin return on investment factors in all these costs so you can get an accurate picture of the profitability of your inventory.
Essentially, the GMROI allows you to calculate the average amount of profit your business generates for every dollar invested in inventory during a given period.
It helps you gauge your business’s ability to transform inventory into cash, above the costs of transporting, storing and preparing inventory.
The GMROI formula allows you to see if your investment in inventory is paying off.
Because it factors in the costs involved with transporting, preparing and storing stock, it helps you understand if your operations and processes are cost-efficient.
It can give you the warning you need to examine the costs involved with fulfilling customer orders and therefore make changes to boost profit.
For example, a low gross margin return on investment may spur you to make changes to the amount of stock you hold, the price it’s selling for, or the mix of products you offer.
It can also allow you to benchmark against competitors, as well as focus on product categories to see if they are profitable or not.
For example, if your business is struggling to sell a particular product, you can perform a GMROI calculation for this product specifically to see if it is worth investing in.
In could be that this product is slow to move off the shelves, but when it does, it sell for a high margin of return. Or, it may have a low margin because it’s racking up storage costs.
A gross margin returns over 1 indicates that a retailor is selling its inventory at a higher price than what it was purchased for and therefore is turning a profit.
While a value exceeding 1 is a solid baseline to aim for, what is considered a ‘good’ GMROI can vary depending on the sector your business is in and the category of products it sells.
Many retailers will consider a gross margin return on inventory investment of between 2 and 3 as a good result.
The return on inventory formula involves dividing your business’s gross profit by its average inventory cost. The return on inventory investment formula is:
Gross Margin Return on Inventory = Annualised Gross Profit / ((Inventory + Opening Inventory) / 2) * 100
Let’s break down the values required for the GMROI formula:
Now that you’re across the return on inventory investment formula, let’s step through how you can perform a GMROI calculation.
For this example, we’ll show you how to calculate GMROI for the past year.
While the return on inventory formula is useful to gauge the profitability of your business's investment in stock, there are certain shortcomings that you need to consider when using it:
So, how can you improve your business’s ability to transform its inventory into profit? Here’s what you can do:
Tracking all the KPIs can be time-consuming and prone to error if you’re calculating them manually.
That’s why many businesses – from startups to enterprises – are turning to financial analysis software programs to automate KPI tracking.
Our cloud-based platform Fathom, for instance, provides visually compelling dashboards that help you quickly gain insight into your business’s profitability, efficiency, cash flow and liquidity.
It offers over 50 default KPIs – including gross margin return on inventory – or you can create your own with its intuitive KPI builder.
This all-in-one financial management platform also offers capabilities for financial statement reporting, cash flow forecasting and consolidated reporting.
Fathom is known for its extensive local support team and its high customization, so you can tailor your insights and reports for specific needs or stakeholders.
For instance, it gives you the ability to easily customise the terminology used in your financial statements, helping you to tailor your reports to your specific needs. Once you are happy, so you can add your own branding and save the report as a custom template for future use.
If you would like to try Fathom for yourself, sign up for our free 14 day free trial.
Gross margin return on inventory is a financial KPI that allows retailers to gauge how well they transform inventory into cash above the costs of transporting, storing and preparing inventory.
The formula calculates the average amount of profit your business generates for every dollar invested in inventory during a given period.
It involves dividing your business’s gross profit by its average inventory cost.
The GMROI calculation formula is:
Gross Margin Return on Inventory Investment = Gross Profit / Average Inventory Cost
For example, let's say a business had a gross profit of $30,000 and an average inventory cost of $20,500. To work out GMROI, you would calculate:
Gross Margin Return on Inventory Investment = $30,000 / $20,500 = $1.46
This means that for each dollar the business spends on inventory, it generates $1.46 in gross margin.
It allows you to see how much profit your business is generating for every dollar it spends on inventory.
The formula factors in the costs of transporting, storing and preparing inventory and tells you how much profit you make from selling inventory above these costs.
A GMROI of 1 means that your business is selling inventory at the same price if was purchased for.
Generally, a value of between 2 and 3 is considered healthy for retailors. However, this can depend on the industry you’re in.
Kit is the Content Marketing Manager for The Access Group APAC and Fathom. He is a former journalist with extensive experience in content writing and copywriting across various industries, including higher education, not-for-profit, and finance sectors.
