The GMROII concept is easy to understand. It also makes intuitive sense. As a retailer, your product mix is a combination of higher/lower margin products that sell at different rates. Would you rather have:
- A product with 50% GM that turns over 2x a year, or
- A product with a30% GM that turns over 4x a year?
GMROI answers that question.
The actual calculations you may come across may vary, depending on whether it uses Dollars or Percentages. Most practitioners take a shortcut calculation that may not be strictly text book, but as long as you consistently use the same method for all your decisions, it does not really matter.
There are two parts to it; the “GM”and the “II”.
The calculation is simply a combination of those two KPIs: Gross Margin and Inventory Investment. (I use two’ I’s – Inventory Investment- but you will commonly see the acronym GMROI with one ‘I’ only.)
In essence, you simply multiply the GM% and the Inventory turn rate (stock turn) with each other. This is the abbreviated (practitioner’s) formula, also know as the ‘turn and earn’ formula.
GMROI (via the Turn & Earn formula) is Gross Margin % times the Inventory Turnover Ratio.
- Sales of $100,000
- Cost of goods sold of $80,000
- Gross margin of $20,000
- Inventory (at cost) of $16,000
In this example, the item would have a gross margin of 20.0% ($20,000 ÷ $100, 000)
And it would have an inventory turnover of 5.0 x ($80,000 ÷ $16,000)
Combining the two figures produces a GMROI of 100.0% (20% x 5)
Remember: Depending on the formula use, your answer may be (for instance) 2.5 or 250 or 250% – and it is all the same thing!
- There is a pretty decent whitepaper by Profit Planning Group uploaded to RetailsmartResultsGroup (registration required) that explores the relative advantages and disadvantages of DPP.
- The textbook GMROI definition is:
($ Gross Profit /$Sales) X ($ Sales/ $ Avg Inventory at cost)
The difference between the textbook and the practitioner’s formulae is that the second term of the above formula (the inventory bit) is NOT actually your stockturn factor. (Stockturn is calculated differently.)
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