GMROI, or Gross Profit Return on Inventory, answers the question “How much money do I get back for every dollar I invest in inventory?” The Gross Profit (or Gross Margin) that is created when you make sales needs to provide sufficient money to operate and grow your business and make a profit for the owners. It makes sense to squeeze all the dollars you can from your inventory. GMROI allows you to discover ways to do this with raising sales or prices.
For a more comprehensive discussion of GMROI, see my blog post “How to Create More Cash Without Raising Sales Prices“.
GMROI is calculated from two numbers: Your Gross Profit and your Average Inventory.
On your income statement, your sales revenue displays as Sales, and the amount you paid for your inventory displays as Cost of Goods Sold (COGS). The difference between Sales and Cost of Goods Sold is your Gross Profit. Gross Profit is the same thing as Gross Margin; Gross Profit is usually expressed in dollars, and Gross Margin as a percentage of sales. I will use these terms interchangeably, because they are two ways of expressing the same thing.
Here’s how to calculate your GMROI, in three easy steps, using your annual Gross Margin (in dollars) and your average Inventory at cost. If you don’t have actual figures for these, use your projected figures.
Step #1: Calculate Gross Margin dollars. The formula is: Sales minus Cost of Goods Sold = Gross Margin. For example (keeping the numbers simple for the sake of the example), if your total sales for the year were $200,000 and your Cost of Goods Sold was $100,000, then $200,000 minus $100,000 = $100,000. Your Gross Margin would be $100,000.
Step #2: Calculate Average Inventory at Cost. To figure your average inventory for a year, add up your ending inventories (at cost) for each month of the year, plus the ending inventory (at cost) for the previous year. Then, to get the average, divide the total of those inventories by 13, the number of inventories in the sum. Let’s assume, again keeping it simple, that the sum of all those inventories (including last year’s fiscal year-end) was $1,300,000. Then, using the formula, $1,300,000 divided by 13 = $100,000.
Step #3: Calculate GMROI. Here’s the formula: Annual Gross Margin Dollars ($100,000) divided by Average Inventory at Cost ($100,000) equals GMROI. So, $100,000 divided by $100,000 = 1.
The “math-adverse” among us can find a GMROI calculator below; just enter your numbers.