Gross Margin Return On Investment - GMROI

Gross Margin Return On Investment - GMROI is an inventory profitability evaluation ratio that analyzes a company's ability to turn inventory into cash above the cost of the inventory. It is calculated by dividing the gross margin, of total inventory or a specific SKU, by the average inventory cost and is used often in the retail industry. The formula is:

GMROI = Gross Margin / Average Inventory Cost

Example 1:

Gross Margin               = $500,000

Beginning Inventory = $200,000
Ending inventory       = $300,000

GMROI = $500,000 / $250,000  (Ave. inventory = $200,000 +$300,000) / 2

GMROI = 2

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This is a useful measure as it helps the investor, or management, see the average amount that the inventory returns above its cost. A ratio higher than 1 means the firm is selling the merchandise for more than what it costs the firm to acquire and stock it. The opposite is true for a ratio below 1. However, this is a ratio best used in conjuncture with other ratios such as inventory turn and average age of inventory.

Just as a ratio above 1 usually means you are selling above cost to acquire, it may also mean that you are over stocked or your margin may be in excess of what competitors are selling for in the market.

Ratios below 1 can mean an under-performing product, obsolete products or just a new product introduced into the portfolio. Again - look at other ratios as part of the decision process.

I believe it becomes more meaningful when used as a piece to the analysis!!