Loading the player...

What is a 'Gross Margin Return On Investment - GMROI'

A 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 calculated as:

GMROI = Gross Margin / Average Inventory Cost

GMROI is also know as the gross margin return on inventory investment (GMROII).

BREAKING DOWN 'Gross Margin Return On Investment - GMROI'

To calculate the gross margin return on inventory, two metrics must be known - the gross margin and the average inventory. The gross margin 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.

Interpretation of 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 1 means the firm is selling the merchandise for more than what it costs the firm to acquire it. 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.

Gross Margin Return on Investment Examples

For example, assume luxury retail company ABC has 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. Therefore, company ABC is selling the merchandise for more than its cost to acquire it.

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. Therefore, it 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 selling the merchandise for less than its acquisition cost. In comparison to company XYZ, company ABC may be a more ideal investment based on the GMROI.

RELATED TERMS
  1. Average Age Of Inventory

    The average age of inventory is the average number of days it ...
  2. Gross Margin

    A company's total sales revenue minus its cost of goods sold, ...
  3. Average Inventory

    Average inventory is a calculation that estimates the value or ...
  4. Inventory Turnover

    Inventory turnover is a ratio showing how many times a company ...
  5. Cost of Goods Sold - COGS

    Cost of goods sold (COGS) is the direct costs attributable to ...
  6. Inventory

    Inventory is the term for merchandise or raw materials on hand.
Related Articles
  1. Investing

    Measuring Company Efficiency To Maximize Profits

    Efficiency ratios can provide indications of profitability, shows how efficiently a company is being managed, utilizes its assets and handles liabilities.
  2. Small Business

    How Gross Margin Can Make or Break Your Startup

    Find out how your startup's gross margin can impact your business, including why a mediocre margin may spell disaster for a budding business.
  3. Investing

    The Difference Between Gross and Net Profit Margin

    To calculate gross profit margin, subtract the cost of goods sold from a company’s revenue; then divide by revenue.
  4. Investing

    A Look At Corporate Profit Margins

    Take a deeper look at a company's profitability with the help of profit margin ratios.
  5. Investing

    Tesla's 3 Key Financial Ratios (TSLA)

    Learn about Tesla Motors, Inc. and the company's key financial ratios, such as gross margin, operating margin and inventory turnover ratio.
  6. Investing

    U.S. Crude Oil Inventories Up (XOM)

    U.S. crude oil inventories are at “historically high levels” for this time of the year, according to the Energy and Information Administration.
  7. Investing

    Gross, Operating and Net Profit Margins

    A company’s income statement includes the company’s gross, operating and net profits.
  8. Investing

    Is Sales Growth Weaker Than Inventory Growth?

    Find out why Goldman Sachs Equity Research is concerned about inventory growth, which appears to be outpacing sales growth for many U.S. sectors.
  9. Investing

    Key Financial Ratios to Analyze Tech Companies

    Understand the technology industry and the companies that operate in it. Learn about the key financial ratios used to analyze tech companies.
  10. Investing

    Ratio Analysis

    Ratio analysis is the use of quantitative analysis of financial information in a company’s financial statements. The analysis is done by comparing line items in a company’s financial ...
RELATED FAQS
  1. Why is it sometimes better to use an average inventory figure when calculating the ...

    For a couple of key reasons, average inventory can be a better and more accurate measure when calculating the inventory turnover ... Read Answer >>
  2. What is the difference between revenue and cost in gross margin?

    Discover the differences between revenue and cost in gross margin, along with an explanation of various measures of profitability. Read Answer >>
  3. How do you calculate inventory turnover?

    Inventory turnover measures how many times inventory has sold during a period and provides insight into a company's inventory ... Read Answer >>
  4. How to calculate the inventory turnover ratio?

    The inventory turnover ratio is a key measure for evaluating how effective a company's management is at managing inventory ... Read Answer >>
  5. Gross Margin vs Operating Margin: What the difference?

    Understand the difference between gross margin and operating margin in relation to evaluating a company's overall profitability ... Read Answer >>
Trading Center