How to Calculate GMROI for a Retail Store
Calculate GMROI to Determine the Health of Your Business
In recent years, a tool to analyze business profitability has become more popular. It is gross margin return on inventory investment (GMROI). It's easy to get stuck in a rhythm of looking at the top line number (sales) when you are a retailer. People make comments such as "sales cures all ills" and often times measure the value of their business based on year-over-year (YOY) sales gains.
However, this narrow view of your retail business can lead to a dangerous ending. I remember when I opened my first retail store. I had a terrific proforma prepared. In fact, my banker said it was the best he had ever seen. But as the first year of business came to a close and the sales were much lower than predicted (20 percent lower), typically this would mean a time for panic. But because I was using GMROI to evaluate my business versus simply revenue and expenses, I was actually in a better place than if I had met my proforma.
My gross margin was much higher than planned and my inventory controls kept me profitable despite the lower revenue.
Typically, inventory makes up about 70 percent to 80 percent of a retail operation's financial assets, meaning the largest drain on your cash. So, it makes sense that the health of your business is directly linked to how well you manage your inventory.
Turnover is another way to view inventory. In this calculation, you can determine the number of months it takes to sell your inventory when viewed over a calendar year. So, if I have 12 of one stock keeping unit (SKU) in stock and sell them in 12 months, then I "turned" my inventory 1 time over the year (related as 1.0). If I sell all 12 in 6 months, then my turn is 2.0.
The formula for calculating inventory turnover is:
Sales (at retail value)
Average Inventory Value (at retail value)
Alternatively, if your accountant carries inventory value at cost, you can calculate inventory turnover this way:
Cost of Goods Sold
-------------------------- Average Inventory Value (at cost)
Therefore, for example, if your store has a sales volume of $1,000,000 a year on an average inventory of $500,000, some would say that was good. However, $1,000,000 on an average inventory of $200,000 would make people be in awe of you. Somewhere in between is where you will end up, but you get the point.
Normally, we will use this information as a way to control inventory. Managing your turns helps you become over-assorted. But, the even turn is not a holistic view of the health of your retail business. Enter GMROI. In this calculation, you are taking your gross margin and dividing it by your inventory value. What you are trying to assess is how much money (cash) your inventory generated for you. This number must be greater than 1.0 or you are done.
The formula for calculating GMROI is:
Gross Margin (dollars) ----------------- Average Inventory Value (at cost)
For example, your GMROI would be 1.1, which is not something to get excited about. Compared to $1,500,000 in gross margin and $500,000 in average inventory cost, which is a 3.0 GMROI.
There is no "right number" for what your inventory turnover or GMROI should be. While there are certainly industry ranges for both inventory turnover and GMROI, every small retailer is unique in their customer bases, merchandise assortments, and vendor structures. The key is to measure your productivity and then work to improve it.
One great resource for benchmarking is retail associations. When I owned my shoe stores, we were members of the National Shoe Retailers Association. Every two years, the association released a business performance report of the stores in the association. This was a great tool, as I received a benchmark against which to measure my business. However, if you find that your Turn is 1.5 and your GMROI is 1.7 and the other stores in your association have a 2.5 Turn, then going from 1.5 to 1.6, while an improvement, indicates that your business is still drastically underperforming.
State retail associations can also be a good resource. If you do not have an association to join, try the retail owners group.
A short-coming of GMROI analysis is that it can be impacted by items such as final stock levels involving closeouts or fashion versus basic merchandise. In our shoe stores, fashionable items that sold, which is what we wanted, would appear better than basic items such as black socks that were kept in a stocking level year round.