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.
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Gross Margin Return On Investment

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:

\mathit{GMROI} = \frac{\text{Gross profit}}{\text{Average inventory cost}}GMROI=

Average inventory cost
Gross 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.

How to Use the Gross Margin Return on Investment (GMROI)

For example, assume luxury retail company ABC has a total revenue of $100 million
and COGS of $35 million at the end of the current fiscal year. Therefore, the
company has a gross margin of 65%, which means it retains 65 cents for each dollar
of revenue it has generated.

The gross margin may also be stated in dollar terms rather than in percentage
terms. At the end of the fiscal year, the company has an average inventory cost of
$20 million. This firm's GMROI is 3.25, or $65 million / $20 million, which means
it earns revenues of 325% of costs. Company ABC is thus selling the merchandise for
more than a $3.25 markup for each dollar spent on inventory.

Assume luxury retail company XYZ is a competitor to company ABC and has total
revenue of $80 million and COGS of $65 million. Consequently, the company has a
gross margin of $15 million, or 18.75 cents for each dollar of revenue it has
generated.

The company has an average inventory cost of $20 million. Company XYZ has a GMROI
of 0.75, or $15 million/ $20 million. It thus earns revenues of 75% of its costs
and is getting $0.75 in gross margin for every dollar invested in inventory.

This means that company XYZ is making only $0.75 cents for each $1 spent on
inventory, which is not enough to cover business expenses other than inventory such
as selling, general, and administrative expense (SG&A), marketing, and sales. For
that XYZ margins are sub-standard. In comparison to company XYZ, Company ABC may be
a more ideal investment based on the GMROI.

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Related Terms
Understanding Cost of Goods Sold – COGS
Cost of goods sold (COGS) is defined as the direct costs attributable to the
production of the goods sold in a company. more
Why You Should Use Days Sales of Inventory – DSI
The days sales of inventory (DSI) gives investors an idea of how long it takes a
company to turn its inventory into sales. more
How to Calculate Net Profit Margin
Expressed as a percentage, the net profit margin shows how much of each dollar
collected by a company as revenue translates into profit. more
Breakeven Point (BEP)
In accounting, the breakeven point is the production level at which total revenues
equal total expenses. Businesses also have a breakeven point, when they aren't
making or losing money. more
Composite Cost of Capital Definition
Composite cost of capital is a company's cost to finance its business, determined
by and commonly referred to as "weighted average cost of capital" (WACC). more
Profit Margin
Profit margin gauges the degree to which a company or a business activity makes
money. It represents what percentage of sales has turned into profits. more

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