Did you know that you can turn inventory into cash that is above the price of the inventory? If not, you should know it’s possible. But how can you calculate the company’s ability to do that? This is possible to the gross margin return on investment ratio.
If you’re here, it’s probably because you want a better insight into what it is and how it works. So, let’s get into it!
GMROI – Overview
Gross margin return on investment, or GMROI for short, is an inventory profitability evaluation ratio. Basically, it measures a company’s ability to turn inventory into money above the cost of the inventory. It is calculated by dividing the gross margin by the inventory cost.
Also, you should know that gross margin is the net sale of goods minus the price of goods sold.
Moreover, keep in mind that if a GMROI is higher than 1, the firm is selling its merchandise for more than its price. At the same time, it’s the opposite if the ratio is below 1.
How is it Calculated?
Before calculating it, you must know two metrics: the gross margin and the average inventory. You calculate the average inventory by summing the ending inventory over a specified period. Afterward, you have to divide the sum by the number of periods.
The gross margin, on the other hand, can be calculated if you subtract a firm’s price of goods sold from the revenue. Afterward, you divide the difference by its revenue.
Now that you know them, it’s time to calculate the GMROI. First, find the average inventory at cost. You can find it if you add the beginning cost inventory for every month, and the ending cost inventory for every month of the period. If you calculate for a season, divide by 7, and if it’s for a year, divide by 13.
Afterward, calculate the item’s gross margin. Once you’re done, divide the sales by the average inventory cost ant times that by the gross margin % to get GMROI.
The Formula Should Look Like This:
Why is it Important?
GMROI is very important to retailers. This metric allows them to know how much they’re earning on for every dollar they invest. As such, if the inventory isn’t selling well, that means that it may be priced too high. However, lowering the price may lead to a smaller gross margin.
Retailers want their sales to be going well, and that’s no surprise. They invest money in the goods they sell, so they want the return to be bigger. In order to find out how the sales perform, they need the GMROI. This metric could let them calculate how well the company performs when it comes to turning inventory into money above the cost of inventory.
If the rate is too low, they need to change something, whereas a ratio of 1 indicates that things are going well. Are you a retailer? Then this article was hopefully of help in providing you with information about the GMROI.