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GROSS MARGIN RETURN ON INVENTORY INVESTMENT (GMROII)

What it is
Gross Margin Return on Inventory Investment, or GMROI (the second “I” is usually dropped), is the measure of inventory productivity and profitability and answers the question, for each dollar I have invested in my inventory, how much gross profit did I generate? The formula for this calculation is Gross Margin Dollars divided by Average Inventory at COST. Just as for the calculation of Stock Turn Rate, the Average Inventory at Cost is calculated by using the Beginning of Month inventory for twelve months and the End of Month Inventory for month 12. This, again, allows for the seasonal fluctuations in inventory that a store must have to meet its needs for the sales plan. The calculations would look something like this:

Correct Calculation of Average Inventory
Month  
BOM MO 1
146,000
BOM MO 2
125,000
BOM MO 3
140,000
BOM MO 4
170,000
BOM MO 5
245,000
BOM MO 6
194,000
BOM MO 7
134,000
BOM MO 8
116,000
BOM MO 9
149,000
BOM MO 10
140,000
BOM MO 11
155,000
BOM MO 12
149,000
EOM MO 12
126,000
   SUM
1,989,000
Average Inventory at Cost
153,000

Completing the math as above and obtaining the Gross Profit from the Year-End Income Statement, the calculation would be 435,000 / 153,000 or 2.84. Some on-line sources recommend for GMROI in a retail store to be 3.2 or higher so that all occupancy and employee costs and profits are covered.

It is important to mention that the answer must be significantly greater than 1.0 to produce a profit for the business. An answer of 1.0 means that an item is only covering the cost of the item but it contributes nothing to the day to day operation of the store. In other words, the store is losing money selling the item. It goes without saying that a calculation of less than 1.0 means that the store is losing money.

Keep in mind that there are times when merchandise is brought into the store with the intention of a loss. These items would include merchandise given away free of charge for promotions, BOGOs, or merchandise gifts. According to some on-line reference guides, a store must achieve a GMROI of 3.2 to hit the break even point.

The Finer Points
GMROI calculations may be used to measure the performance of the entire store but it is more effective when used for a particular classification or category of merchandise over a year’s time. Here’s an example. Which Category is most profitable?

SALES
GROSS MARGIN
GM%
AVG COST OF GOODS SOLD
GMROI
CATEGORY 1
325,000
195,000
60%
176,420
1.11
CATEGORY 2
250,000
135,000
54%
85,500
1.58
CATEGORY 3
175,000
124,250
71%
55,670
2.23
CATEGORY 4
115,000
47,150
41%
15,145
3.11

If you just glanced at the table, you may answer that Category 1 is the most profitable because it has produced the most sales with a nice high Gross Margin %. Unfortunately, this may not be the case.  Perhaps there is a large amount of merchandise that is outdated or damaged. Stored merchandise brings down the profitability performance of the entire category—and the performance of the store as a whole. In the example, the “best,” most profitable performer is Category 4. Although it has the lowest Gross Margin, it moves regularly requiring a smaller financial investment and giving a much better return on that investment.

A short-coming of GMROI analysis is that items with high sell-offs (i.e. the final stock level falls towards zero at the end of the season) may appear to perform better than items with more consistent inventory levels. Fashion items that totally sold off in-season will appear more favorably than basic items that are replenished by frequent reorders. This is particularly evident when analyzing shorter time periods or item level information rather than department information. While the calculation can be performed with fewer than twelve months of data, it is not normally recommend. The Open-To-Buy is calculated over a year’s performance; it is planned that way, so check category performances annually also.

What it is not
GMROI is not the same as Cumulative Gross Margin although there are web sites using the two terms interchangeably. Cumulative Gross Margin is based on Stock Turn Rate (which does indeed affect GMROI as a slower turn usually requires a larger inventory investment up front) and the Gross Margin %. Perhaps Gross Margin % and Gross Margin Dollars coming from the Income Statement are closely related; however, Stock Turn Rate, a retail calculation based on a year of retail activity, and Beginning of Month (BOM) Inventory at Cost is a financial statement number and as such these do not hold the same similarities. 

Ways to Improve GMROI
Increase your Stock Turn Rate. Increase your Initial Markup %. Decrease Markdowns. Have fewer “sales” but more events. Hold back some of your Open-To-Buy budget to take advantage of in-season purchases. Run shop with a lean inventory and use special orders. A savvy retailer can weather all kinds of “bumps in the road” and financial storms with a solid, lean inventory. Special orders can be another way to get a customer to come back into the store and that offers another opportunity to sell them an extra item or two.   

I believe that the best way to improve GMROI is by using an Open-To-Buy. An Open-To-Buy, the retail store’s written plan for profit, that is used and revised as needed during the year will help the buyer adjust to practical purchasing for the business. Additionally, by holding some money back each season, you will be able to make in-season adjustments to fit your customers’ needs and wants which increase your profit.

Our Open-To-Buy is priced for small and mid-sized, independent retail establishments. If your profit is not as much as you’d like, consider using The Retail Management Advisor’s Open-To-Buy Service. For an emailed, no-obligation service quote click here. 

 

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