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Inventory management provides a significant challenge for many store owners. Evaluating inventory turnover in terms of profit margin gives you an idea of the profitability of categories of goods so that you can better plan your purchases. The GMROI, or gross margin return on investment, is a formula that allows you to quickly assess how many times you earn your original inventory investment back in a given period of time. Many retailers analyze data a year at a time, but quarterly is more useful if your business is seasonal.
Decide what inventory you want to analyze. You may want to do calculations for the entire store, or you may be concerned about certain departments or categories of goods. As you get more familiar with the formula, you may want to perform several different calculations so you can compare the overall profitability of different segments of your business.
Determine your total sales and subtract the cost of goods for these items. For example if your toy store sold 300 rubber balls at $2 each your total sales is $600. If they cost you $1 each plus $5 for shipping all 300, then your cost of goods is $305. Your gross profit margin is 600 minus 305 is $295.
Convert your gross profit margin to a percent. Divide your gross profits in dollars by total sales and multiply by 100. Continuing the example, this gives you 295 divided by 600 equals .49. Multiply by 100 for a gross profit margin of 49 percent.
Calculate your inventory turns. This tells you how quickly your merchandise sells. To find your inventory turns, divide your cost of goods sold by the total inventory cost for those items. For example, the cost of the balls sold in Step 2 was $305. You have an average of $200 worth of balls, at cost including freight, in inventory during the year or quarter. To calculate turns you divide 305 by 200 for a turn value of 1.5.
Combine your gross profit margin values with your inventory turns to determine how much money you make from each dollar's worth of inventory you have. Use the formula:
gross margin percent divided by cost of goods sold, or 1 minus gross margin percent, multiplied by the inventory turn value. For example: .49 divided by .51, times 1.5 equals 1.44.
Interpret your results. You profit to turns ration, or GMROI, was 1.44 for the balls in your inventory. This means that balls earn you $1.44 in gross profit for each $1 you have in inventory during the analysis period. Compare this value with the GMROI for other items you stock to determine if it is producing at an appropriate level or if you should replace it with a different item.
Decide what inventory you want to analyze. You may want to do calculations for the entire store, or you may be concerned about certain departments or categories of goods. As you get more familiar with the formula, you may want to perform several different calculations so you can compare the overall profitability of different segments of your business.
Determine your total sales and subtract the cost of goods for these items. For example if your toy store sold 300 rubber balls at $2 each your total sales is $600. If they cost you $1 each plus $5 for shipping all 300, then your cost of goods is $305. Your gross profit margin is 600 minus 305 is $295.
Convert your gross profit margin to a percent. Divide your gross profits in dollars by total sales and multiply by 100. Continuing the example, this gives you 295 divided by 600 equals .49. Multiply by 100 for a gross profit margin of 49 percent.
Calculate your inventory turns. This tells you how quickly your merchandise sells. To find your inventory turns, divide your cost of goods sold by the total inventory cost for those items. For example, the cost of the balls sold in Step 2 was $305. You have an average of $200 worth of balls, at cost including freight, in inventory during the year or quarter. To calculate turns you divide 305 by 200 for a turn value of 1.5.
Combine your gross profit margin values with your inventory turns to determine how much money you make from each dollar's worth of inventory you have. Use the formula:
gross margin percent divided by cost of goods sold, or 1 minus gross margin percent, multiplied by the inventory turn value. For example: .49 divided by .51, times 1.5 equals 1.44.
Interpret your results. You profit to turns ration, or GMROI, was 1.44 for the balls in your inventory. This means that balls earn you $1.44 in gross profit for each $1 you have in inventory during the analysis period. Compare this value with the GMROI for other items you stock to determine if it is producing at an appropriate level or if you should replace it with a different item.
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