Gross Margin Return on Investment

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Gross Margin Return on Investment (GMROI)

The GMROI is the amount of gross profit obtained for every dollar invested in inventory. Since the primary reason for any business investment is to improve or directly generate profit, one needs to evaluate the investment in inventory in relation to the gross margin generated from that investment. In other words, what did the turn earn the company?

The formula for gross margin is:

(gross profit dollars / average inventory value ) * 100

Item A – (4,500/19,500) * 100 = 23.08%

Item B – (4,500/49,500) * 100 = 9.09%

In the above example, there is more profit for each sales dollar when item A is sold. To put it another way, a lot more of item B must be sold to earn the same gross profit as item A.

If gross profit is the difference between the COGS and the sales dollars, the total inventory cost for item A is $15,000.00 or $19,500.00 less $4,500.00. The total inventory cost for item B is $45,000.00 or $49,500.00 less $4,500.00.

Assuming the average inventory value for each item is $5,000.00, the inventory turns on each item is:

Item A – 15,000 / 5,000 = 3 turns

Item B – 45,000 / 5,000 = 15 turns

Evidently, since both generated the same gross profit, the number of inventory turns cannot be the only performance indicator. Because typically sales expenses increase with the volume of sales transactions, item A is a better performing product. Distributors should look for higher turns on lower margin items.

References

1. TECSYS Inc.