Gross Margin Return on Investment (GMROI) is a financial metric that measures the profitability of a product or a group of products. It is used to determine the efficiency of inventory management by calculating the amount of profit generated for each dollar invested in inventory.

The formula for calculating GMROI is:

Formula

GMROI = Gross Margin / Average Inventory Cost

where Gross Margin is the total sales revenue minus the cost of goods sold, and Average Inventory Cost is the average cost of the inventory over a specified period of time

Example

Let’s consider an example to illustrate this. Suppose a company sells widgets and has the following information:

• Total sales revenue = $500,000
• Cost of goods sold = $300,000
• Average inventory cost = $50,000

To calculate GMROI, we first need to find the Gross Margin, which is:

Gross Margin = Total sales revenue – Cost of goods sold = $500,000 – $300,000 = $200,000

Next, we need to calculate the Average Inventory Cost, which is:

Average Inventory Cost = (Beginning Inventory + Ending Inventory) / 2 = ($40,000 + $60,000) / 2 = $50,000

Now we can calculate the GMROI by dividing the Gross Margin by the Average Inventory Cost:

GMROI = Gross Margin / Average Inventory Cost = $200,000 / $50,000 = 4

This means that for every dollar invested in inventory, the company is generating $4 in gross margin. A GMROI of greater than 1 indicates that the company is generating a profit on its inventory investment, while a GMROI of less than 1 indicates that the company is losing money on its inventory investment.

GMROI is a useful metric for evaluating inventory management strategies and for comparing the profitability of different products. It helps companies to optimize their inventory levels and avoid tying up too much capital in inventory that is not generating sufficient profit.