An inventory profitability evaluation ratio that analyzes a firm’s ability to turn inventory into cash above the cost of the inventory. An important tool in analyzing inventory, sales and profitability is GMROI (also known as GMROII) which stands for Gross Margin Return On Inventory Investment. The GMROI calculations assist buyers in evaluating whether a sufficient gross margin is being earned by the products purchased, compared to the investment in inventory required to generate those gross margin dollars.It is calculated by dividing the gross margin by the average inventory cost and is used often in the retail industry.
Gross margin return on investment is also know as the “gross margin return on inventory investment” (GMROII).
This is a useful measure as it helps the investor, or management, see the average amount that the inventory returns above its cost. A ratio higher than 1 means the firm is selling the merchandise for more than what it costs the firm to acquire it. The opposite is true for a ratio below 1.
GMROI can be expressed as either a percentage or dollar multiple. Many retailers calculate GMROI at a product family or department level but it can also be calculated at an individual item level.
GMROI (%) = gross margin (%) x [sales / average inventory at cost]
where gross margin (%) = (sales – cost of goods sold) / sales
and average inventories at cost for one year = add ending inventory at cost for every month of the year plus the ending inventory at cost for the previous year and then divide by 13.
Analysis software which automates the calculation of GMROI at an item level and then allows the user to input exception monitoring based on business logic is ideal. This setup provides significant time savings and proactively alerts a user to problems.
For example, say a firm has a gross margin of $129,500 and an average inventory cost of $83,000. This firm’s GMROI is 1.56, which means it earns revenues of 156% of costs.