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. Average Inventory

    Average inventory is a calculation that estimates the value or ...
  3. Beginning Inventory

    Beginning inventory is the book value of inventory at the start ...
  4. Days Sales Of Inventory - DSI

    The days sales of inventory value (DSI) gives investors an idea ...
  5. Inventory

    Inventory is the term for merchandise or raw materials on hand.
  6. Periodic Inventory

    The periodic inventory system is a method of inventory valuation ...
Related Articles
  1. Investing

    How to Calculate Average Inventory

    Average inventory is the median value of an inventory at a specific time period.
  2. Investing

    How to Analyze a Company's Inventory

    Discover how to analyze a company's inventory by understanding different types of inventory and doing a quantitative and qualitative assessment of inventory.
  3. Investing

    Key Financial Ratios for Retail Companies

    Using the following liquidity, profitability and debt ratios, an investor can gather deeper knowledge of a retail company's short-term and long-term outlook.
  4. 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.
  5. 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.
  6. 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.
  7. Investing

    Analyzing Operating Margins

    Learn how to analyze operating margins and how to put this aspect of equity analysis to work.
  8. Investing

    A Look At Corporate Profit Margins

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

    Understanding Periodic vs. Perpetual Inventory

    An overview of the two primary inventory accounting systems.
  10. 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.
RELATED FAQS
  1. How can a company have a negative gross profit margin?

    There are several reasons why a company might experience a loss in gross margins, including poor marketing, ineffective pricing ... Read Answer >>
  2. How do gross margin and contribution margin differ?

    Gross margin and the contribution margin are metrics used to measure profitability, but each uses a different method. Read Answer >>
  3. Does working capital include inventory?

    Learn about inventory that is part of current assets and working capital, which is the difference between current assets ... Read Answer >>
  4. What is the formula for calculating gross profit margin in Excel?

    Understand the basics of the gross profit margin including its interpretation as a measure of profitability and its calculation ... Read Answer >>
  5. Profit margin versus operating margin: What's the difference?

    There are some distinctions between profit margin and operating margin. Both measure efficiency of a firm, but one takes ... Read Answer >>
Trading Center