GMROI

How GMROI is worked out

The sum is the gross margin earned over a period, divided by the average inventory at cost over that same period. At cost, every time: the top half is a margin and the bottom half has to be on the same basis, and mixing cost and retail values is the most common way this figure goes wrong.

The result is a ratio. A GMROI of 2.5 means every pound of stock investment returned two pounds fifty of gross margin over the period. Some businesses report it as 250 per cent instead; the arithmetic is identical and the house style only matters because mixing the two eventually produces a comparison nobody can read.

What makes GMROI worth the trouble is what it combines. Gross margin percentage says how much you make on a sale. Inventory turnover says how often you make it. GMROI multiplies them, which is why a thin margin turning fast and a fat margin turning slowly can land on the same number, and why the comparison between them is finally an honest one.

There is no good number

GMROI is not comparable across trades: a jeweller and a grocer live at opposite ends of the margin-and-turnover trade and both can be excellent businesses. Published benchmarks exist and are not worth chasing.

Where it earns its keep is ranking lines inside your own range. Sort your categories by GMROI and the bottom of the list is usually not what the margin report suggested. The slow line with the comfortable mark-up is the one this figure is designed to expose, because the margin percentage flatters it and the capital it consumes never appears on the sales report at all.

In practice

Line A sells £160,000 a year at a 25 per cent gross margin, so £40,000 of margin on £120,000 of goods at cost, held on average stock at cost of £16,000. It turns 7.5 times. GMROI is 40,000 divided by 16,000, or 2.5.

Line B sells £80,000 a year at a 50 per cent gross margin, so also £40,000 of margin, on £40,000 of goods at cost, held on average stock at cost of £80,000. It turns half a time a year. GMROI is 40,000 divided by 80,000, or 0.5.

Identical gross margin in pounds. Five times the capital. And line B is the one with the impressive margin percentage, which is exactly why it survives on a report that shows margin and not GMROI. Put the 17 per cent inventory carrying cost from that entry against line B's £80,000 of stock and the £13,600 a year it costs to hold eats a third of the margin it earns. The figures here are an illustration.

What moves the figure

• Buying quantity. A bulk discount raises margin percentage and lowers turnover. GMROI is the figure that settles whether the deal was worth it, and often it is not.
• Markdowns. They cut margin and raise turnover at the same time, so their effect on GMROI is genuinely ambiguous and worth calculating rather than assuming.
• Dead and slow stock in the denominator. It earns nothing and sits in the average all year. See dead stock.
• Supplier terms. A supplier who will deliver monthly instead of quarterly improves GMROI without touching price, and is usually easier to negotiate than a discount.
• Range width. Every additional line carries stock. GMROI by category is the most honest input into a range review.
• Whether you measure at cost. Worth repeating, because a GMROI that looks surprisingly healthy is usually a retail-value denominator.