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Do You Have the Right Stuff? Use GMROI to Find Out
Success in business should be simple, right? Just buy the right quantity of stuff at the best price, with good markups, and sell this "right stuff" within reasonable time frames. What's so hard about that?
Success in business should be so simple, really. Generally, you have to buy the right quantity of stuff at the best price, with good markups, and sell this "right stuff" to customers within reasonable time frames. What's so hard about that? Well, for one thing, what makes the right stuff right? And what makes a markup good?
As usual, when you look only at size – whether you're talking sales, margins, or inventory levels - you can come up with a less than satisfying result. What you really want to be looking at are your numbers in relation to each other to get your true picture.
These related numbers, also called ratios, are important because they create benchmarks to both compare and measure your performance - regardless of sales size. One of the key benchmarks used for inventory is Gross Margin Return on Inventory (GMROI). GMROI helps people decide which of the "right stuff" they should be selling.
For example, a successful jeweler prided himself on his large selection and sales of watches. That was, however, until he realized that his watch department's overall GMROI was significantly lower than some of his other, less well-stocked (and less well-promoted) departments. As he put it, "I have been in denial for over 13 years regarding the affect a slow turn and low margin has on my business. Until you see the indisputable graphic analysis, you can stay in this euphoric state forever."
Whether you call it euphoria or denial (like our jeweler friend) the first step is admitting you have a problem! Second, you need to do some simple calculations. Here's how you calculate your overall GMROI:
- Calculate your gross margin, which is sales minus cost of goods sold.
- Calculate the value of your inventory at cost.
- Divide your gross margin dollars by your total inventory.
For example, if your total gross margin for a period is $1,400,000 and your inventory for the same period is $900,000, your GMROI is 1.55. In other words, this means that for every dollar you have invested in inventory, you are getting back $1.55 to pay expenses and make a profit. Besides the fact that it helps you measure return on your biggest investment, it's handy for several reasons:
GMROI works for any type of company with inventory, any size store, and further, any department or merchandise classification. It will work for each category in each department, each class in each category, each color, each size in each class and so on. For example, if you know your gross margin and inventory for a specific department, you can calculate the GMROI for it. This puts all your categories on the same footing, regardless of sales size, and allows you to measure return across the categories. Once you start looking at GMROI by department, it will open your eyes to the areas you want emphasized (or de-emphasized).
For example, our jeweler friend has decreased the amount and categories of watches he carries to free up some capital to invest in other, more profitable inventory. And within his existing watch department, he's re-balanced it to beef up the watch lines with higher GMROI's and decrease the watch lines with lower GMROI's. He states, "I'm trying to change this situation by reducing my watch purchases and promote a watch trade-in special. I'm trying to replace only what I need to be in compliance with the lines I'm keeping. A few others I will not re-buy and terminate the lines."
You can also compute your GMROI by vendor (provided you can classify your inventory by vendor). Think of the interesting conversations you could have with your vendors' partners on this topic! Wouldn't knowing your GMROI by vendor help when it came time to budgeting your purchasing dollars at the next trade show?
You can compare your GMROI to others in your industry. According to the Risk Management Institute (RMA), the average GMROI for jewelry businesses, in the $1-$3M in annual revenue range, is 1.01. For retail hardware it's 1.72, tire stores it's 3.32, boat dealers it's .8, and grocery it's 4.99.
The Retail Owners Institute's website lists GMROI's for 56 different industries. Your trade association might be able to provide you with this data as well.
It gives you the same tool the big boys use. Although GMROI analysis is used extensively by many larger businesses, we find that very few smaller ones make use of this benchmark. It's a shame, because it's a great planning and decision-making tool.
We're not saying size doesn't count. Of course it does. But manage your GMROI results and you'll enable your inventory to work for you and generate increased profits at whatever your sales level.
Reprinted by permission from Business Resource Services, Inc. Seattle, Washington
Learn more about the author, Berry Zimmerman.
- return on inventory
- business measurement
- financial performance