GMROI: which products earn their shelf space?

A product can have a lovely margin and still be a poor use of your money. Imagine a high-margin item that sits on the shelf for a year before it sells. Compare it with a modest-margin item that sells every week. Which one pays you better?

GMROI answers that question. It stands for gross margin return on inventory, and it looks like a mouthful. The idea is simple: for every dollar you have tied up in stock, how many dollars of gross profit do you earn in a year?

The formula

Take your gross margin in dollars for the year, which is sales minus the cost of what you sold, and divide it by your average stock value at cost. A result above 1 means the stock earns back more than it costs. Below 1 means it does not cover itself.

Comparing two categories

The tools make twice the gross profit of the fasteners, and look better on a sales report. But they need seven times as much money in stock. Each dollar in fasteners works more than three times as hard.

What to do with it

• Look at the categories with the lowest GMROI. Do you really need that much stock?
• Look at the highest. Could you stock a little more, and sell more?
• Check items inside a category, since an average can hide a star and a dud.
• Track it each quarter. If it drifts down, stock is building up faster than profit.

Why it is worth the arithmetic

It connects two things shops usually look at separately: how much profit a product makes, and how much money it ties up. It points you at where a dollar of stock would do better, which is often a more profitable decision than finding another supplier discount.

It pairs well with inventory turnover: turnover tells you how fast stock moves, and GMROI tells you whether the moving is profitable.