Is GMROI Actionable?

GMROI is easy to use and provides a simple mechanism how to evaluate the profitability of cash investments in inventories. Systematic improvements in GMROI can make the company more profitable and improve its return on assets (ROA). Due to GMROI’s simplicity there are shortcomings as well, which must be taken into account to prevent possibly harmful decisions.

The formula

GMROI formula can take a different form. The simplest one is: annual gross profit / average inventory at cost.

It can also be written in mathematically equivalent forms like:

• (Margin % / (100% – Margin %)) * Annual Inventory Turns

• (Margin / COGS) * Annual Inventory Turns

• Margin % * (Sales / Average Invnetory at cost)

As it is possible to calculate the metric for different time periods – year, season, month or week, it must be taken into account that the formula result will be different.

For example:

150 000 annual gross profit / 30 000 average inventory = GMROI 5.0

10 000 July gross profit / 30 000 average inventory = GMROI 0.33

Those time differences make GMROI values of different time periods incomparable.

Fix the problem: Average weekly GMROI

The solution to this problem is to use average weekly (or monthly) GMROI. This removes time from the equation and the formula takes the form:

(gross profit for the time period) / average inventory

where average inventory = (sum of each weeks opening inventory at cost value + closing inventory of the last week) / (total number of weeks + 1)

Now, the GMROI-s of weeks and years become comparable.

How to improve GMROI

For improving GMROI there are basically 2 main leverages:

1. Improve gross profit

   • Raise prices

   • Reduce COGS

   • Better management of markdowns

2. Improving inventory turnover

   • increasing sales volumes with the same inventory level

   • reducing innvetory levels and keeping the same sales volumes

Shortcomings of GMROI

Making merchandising decisions solely on GMROI can be harmful, as it has several shortcomings:

• GMROI favors products with lower gross margin and higer turnover

• doesn’t take into account different handling cost structures of different products

• Items with high sell-offs appear better than those with constant inventory levels

• doesn’t take into account the vendor’s payment terms and it’s impact on cash flow.

Is GMROI an actionable metric?

If you compare two similar products and one has a higher GMROI, then it’s quite clear you should focus on the product with a higher GMROI.

Once the product categories are different and have a different cost structure, things get more complicated. You should take into account several factors which are not readable from gross profit and inventory turnover:

• amount of floor space allocated for categories. If a category requires more space, its costs are higher, but this is not evident from GMROI. You could use GMROS (Gross Margin Return on Space) instead.

• amount of labor needed to support the sales (customer service and store associates time). You could use GMROL (Gross Margin Return on Labor) instead.

• if there are great discrepancies from vendors payment terms or logistics. If some products are sold on consignment or drop-shipped then GMROI is not really a meaningful metric for performance evaluation.