Gross Margin Return on Investment (GMROI)
The gross margin return on investment (GMROI) is a statistic used to evaluate the profitability of each dollar spent on inventory. To obtain the GMROI, divide the gross margin by the typical inventory cost.
A key indicator of whether a retail company will end the year in black or red is GMROI. Since it displays the average amount that inventory returns to the investor or management over its cost, the GMROI is a helpful metric. A ratio higher than one indicates that the business has a healthy balance between sales, margin, and inventory costs because it sells the product for more than it pays.
It contrasts the gross profit you make from selling the same inventory with the cost of acquiring, shipping, and maintaining inventory and the expense of fulfilling client orders for that inventory. Understanding your GMROI may reveal inventory issues that keep you from making more money, even though many stores are happy with a high gross margin.
Calculating Gross Margin Return on Investment
The average inventory and the gross margin return on the merchandise are the two metrics that analysts must understand to calculate them. You calculate a corporation’s gross profit by deducting its revenue from its cost of goods sold( COGS). The company uses its revenue to divide the difference. The average inventory is calculated by dividing the total by the number of periods and accounting for instances where an inventory component is outdated. The company is profitable if the GMROI is always higher than one. You should also assess the market GMROI standards to ensure your business is competitive.
GMROI = Gross Profit / Average Inventory Cost
Gross Profit
We calculate gross profit as the sum of all sales less the total cost of goods sold. The total cost of the products sold includes all sales-related variable costs. Gross profit is a metric for cost-control effectiveness that companies can use to assess how well other businesses are doing. The shop will determine the gross profit margin, a more accurate representation of the store’s effectiveness over a given period.
Gross Profit = Total Sales – Total Costs of Goods Sold
Gross Profit Margin = (Gross Profit / Total Revenues) x 100.
Average Inventory Cost
We divide the cost of the products sold by the number of inventory units available to determine the average inventory cost. You can use the average inventory cost to compare the prices of goods for sale at different times or locations.
You can estimate the inventory needed to maintain sales by calculating the average inventory cost. In addition, we calculate inventory losses brought on by theft, shrinkage, damage, and product expiry using this method.
Average Inventory Cost = ( Previous Inventory + Current Inventory) / The Number of Periods
Importance of Gross Margin Return on Investment
A higher gross margin return on investment indicates a better deal. The idea shows how profit and inventory costs are directly related. The statement outlines the maximum profit an inventory unit can develop for a business.
GMROI needs to be able to show a significant difference based on the market segmentation level. Additionally, we must consider factors like the period and the type of inventory when calculating GMROI.
Improving Your Gross Margin Return on Investment
Small businesses are thrilled to see a rise in sales, but administrative costs are also rising. Additionally, as you add new items, you incur additional costs for buying them( supplier charges), transportation( warehouse fees), and shortfall( when a product is no longer in stock).
Price adjustments could be challenging. Raising product prices is a surefire way to boost sales and GMROI, but this is only sometimes the case. However, you can lower your products’ cost.
A key statistic is to separate successful products from unsuccessful ones and winning items from deadstock GMROI. Additionally, it might anticipate which of your locations will deliver the best return on investment this year. It depends on the products you provide. Luxury shoemakers typically take a long time to sell their products, which lowers GMROI, whereas high-selling clothing retailers need better margins.
The GMROI calculation provides insightful data on your inventory investment’s effectiveness. In addition, you will gain a new perspective when you consider each product line’s combined gross margin profitability and turnover.
Example of Gross Margin Return on Investment
A fishing boat company sells 15 boats annually for an average price of $4,500. The company has a gross margin of 40%, giving them a gross margin of $2,700 per boat. The owner of the company had an average inventory of $24,000.
In this scenario, the gross profit return on investment is 1.6875, dividing the total gross margin of $40,500 ($2,700 x 15) by the average inventory of $24,000.
Drawbacks of Gross Margin Return on Investment
This strategy will only give you a partial view of your company’s profitability and won’t tell you how effectively you use your money for real estate, labor, transportation, or marketing. Due to underinvestment in other areas, you may have a high GMROI but still, lose money.
This calculation may not reveal the success of individual goods by calculating the annual cost of goods sold and revenue, which combines runaway hits and money-sink product lines into a single statistic. To successfully use this measure, you must become more precise.
What Is A Good Gross Margin Return?
Some sources claim that to cover all occupancy, staff, and profit expenses, a retail business’s GMROI must be 3.2 or higher.
A key statistic for separating successful product categories from unsuccessful ones and winning items from deadstock is GMOI. Additionally, it might let you know which of your locations is anticipated to deliver the best return on investment this year. You’ll be well on your way to success if you manage your GMROI.
