What Is the Gross Margin Return on Investment (GMROI)?
The gross margin return on investment (GMROI) is an inventory profitability evaluation ratio that analyzes a firm's ability to turn inventory into cash above the cost of the inventory. It is calculated by dividing the gross margin by the average inventory cost and is used often in the retail industry. GMROI is also known as the gross margin return on inventory investment (GMROII).
Key Takeaways
- The GMROI shows how much profit inventory sales produce after covering inventory costs.
- A higher GMROI is generally better, as it means each unit of inventory is generating a higher profit.
- The GMROI can show substantial variance depending on market segmentation, the period, type of item, and other factors.
Understanding the Gross Margin Return on Investment (GMROI)
The GMROI is a useful measure as it helps the investor or manager see the average amount that the inventory returns above its cost. A ratio higher than one means the firm is selling the merchandise for more than what it costs the firm to acquire it and shows that the business has a good balance between its sales, margin, and cost of inventory.The opposite is true for a ratio below 1. Some sources recommend the rule of thumb for GMROI in a retail store to be 3.2 or higher so that all occupancy and employee costs and profits are covered.
How to Calculate the Gross Margin Return on Investment (GMROI)
The formula for the GMROI is as follows: GMROI=Average inventory costGross profit
To calculate the gross margin return on inventory, two metrics must be known: the gross margin and the average inventory. The gross profit is calculated by subtracting a company's cost of goods sold (COGS) from its revenue. The difference is then divided by its revenue. The average inventory is calculated by summing the ending inventory over a specified period and then dividing the sum by the number of periods while considering the obsolete inventory portion scenarios as well.