The Most Important Retail Metric: GMROI
Sales, profitability and cash flow are tied to your ability to manage inventory productively. By David McMahon
n my previous article on performance indicators, I wrote about how the correct combination of inventory and income to sales can increase cash flow. Now, I’m going to focus on Gross Margin Return on Inventory (GMROI), the most important metric in retail. GMROI connects the profits made on all sales transactions to the amount of product investment needed to support those transactions. Here’s the equation for GMROI: Sales – Cost of Sales (on annual) = Gross Margin Dollars / Average Inventory Carried = GMROI
GMROI as an Operational Indicator Let’s take two scenarios: Company X and Company Z. Both produce $5 million annually. However, Company X has 2 percent lower cost of goods and thus 2 percent higher gross margin than Company Z. On the top line, Company X is $100,000 more profitable than Company Z annually. Using this information, which business would have a higher return on investment on the sale of its product? We don’t have enough information to answer this question yet. To get a return on investment we need to know what the investment is. After knowing this, we can figure how many times the investment turns. Now, by adding the average investment in inventory to the mix for both companies we can see the return. Company X carries $1 million to support its sales volume. Company Z carries $750,000. As a result, Company X produces $2.25 in gross margin dollars for each dollar it invests. Company Z makes $3.13. Back-of-napkin math shows that Company X makes 88 cents less that Company Z. Another way to look at this is as a percentage. Company X has a 225 percent return on inventory. Company Z has a 313 percent return. I have seen similar results to both these cases many times in the field. With this example, I cannot really say that Company Z is doing a better job with its business than Company X. Their business situations are probably not identical. In fact, it may be that Z has the biggest opportunity to improve in gross margin. The important thing for any company to realize is that GMROI is an important performance indicator, and that consistently tracking it and developing strategies around improving it will help your store grow.
JUNE | 2015
GMROI as an Operational Tool GMROI should be used as a tool to improve operations. First, it should be monitored in all these areas to capitalize strengths and weaknesses: • Overall organization • Each store • All merchandising categories • All merchandise vendors • Individual items or groups of items Then, strategies and actions should be executed to improve. Here is a basic list of merchandise areas in which you can use GMROI as a business advancing tool: Best-seller merchandise—Focus in on top-tier inventory. This produces high-level GMROIs. Love it. Dog merchandise—Focus in on bottom-tier inventory. This produces low-level GMROIs. Leave it. Border-line merchandise—Focus in on questionable inventory. This produces average-level GMROIs. Decide what to do with it. Bottom line: I have seen the most successful operations use GMROI as a guiding force in their day-to-day operations. They use it to direct their entire business strategy. David McMahon is an industry business consultant and certified management accountant. He is director of consulting and performance groups for PROFITsystems, a HighJump Product. He can be reached for questions or comments at firstname.lastname@example.org.
HOW DOES YOUR STORE STACK UP? Would you like to know how your store compares to others in the industry? This year, with your help, the NAHFA is surveying retailers across the country. Once the data is gathered, we will compile the results and release a metrics-performance report so you can see where you are in the many key performance indicators that matter. Best of all, the service and your store’s results are free! For more information visit: http://www.nahfa.org/rpr.
5/13/2015 5:30:21 PM