As store owners, everything in our business requires advance funding before we have anything to offer customers. We are truly investors more than we are shop-keepers, but instead of a tidy, manageable investment portfolio we have tens of thousands of inventory items to manage individually.

Inventory profitability and GMROI

While there are many ideas about what “key value” makes a store profitable, a single factor just doesn’t provide enough information. Evaluating inventory investments by gross margin return-on-investment (GMROI) considers all factors. An item could have a decent velocity code but be a poor investment, while another item could have a poor margin or anemic sales and be a great investment. GMROI accounts for these factors to provide a true picture of an inventory item’s investment performance.

In our experience, inventory requires a GMROI of at least 300% per year on average to be considered profitable. Some inventory investments will exceed that threshold, which is necessary to subsidize under-performers.

The impact of overstock on your bottom line

One of the most devastating factors against GMROI is overstock. GMROI on overstock is zero. Stock depth should be enough to meet expected demand for 2-4 order cycles and nothing more. Purchase cost contributes directly to margin, but it’s not the most important factor in GMROI. Order cycle and minimum order quantity are critical to a healthy GMROI. The more frequently product can be ordered, the lower it’s warehousing costs. Higher investments due to high order minimums lower GMROI and steal dollars from other inventory investments.

A case study: Order quantity and GMROI

To illustrate the impact of order quantity on GMROI, let’s look at an item that typically requires a $48.00 investment due to high order minimums, and how paying a slightly higher purchase price results in a higher GMROI.

Item

Supplier 1

Supplier 2

Supplier 3

Inventory Stocking Depth (in weeks)

2

2

2

Minimum order quantity

24

1

6

Sales per week

3

3

3

Order quantity per order cycle

24

6

6

Purchase cost per unit

$2.00

$2.35

$2.15

Retail price
per unit

$2.99

$2.99

$2.99

Investment

$48.00

$14.10

$12.90

52-week profit

$154.44

$99.84

$131.04

GMROI

322%

708%

1016%

Supplier 1 requires a minimum order of 24 units at $2.00 each. Supplier 2 has no minimum, and sells the same unit for $2.35 each. Supplier 3 requires a minimum order of 6 and a purchase price of @2.15 per unit. A higher purchase price more than doubled GMROI when using Supplier 2 or Supplier 3.

Yes, the profit (in dollars) was lower. However we have $33.90-$35.10 left to invest in another product in the two scenarios with higher purchase costs and lower order minimums. If we invest those dollars in another item that meets our required 300% GMROI, the profit dollars are recouped (and then some):

item

Supplier 1

Supplier 2

Supplier 3

Investment in additional inventory

$0.00

$33.90

$35.10

52-week profit for additional inventory at 300% GMROI

$0.00

$101.70

$105.30

Total investment

$48.00

$48.00

$48.00

Total 52-week profit

$154.44

$201.54

$236.34

Total GMROI

322%

420%

492%

Business-as-usual invested $48.00, earned $154.44 and achieved a GMROI of 322%.

Paying a higher purchase price to avoid overstock cost the same $48.00 in investment dollars, earned between $201.54 and $236.34, and resulted in an overall GMROI of 420-492%.

GMROI and your bottom line

Careful evaluation of high minimum order products and consideration of alternate sources may be your ticket to increasing your GMROI and, ultimately, your bottom line.

This concept of measuring an inventory item’s performance using GMROI and increasing your bottom line through tight inventory control should be fundamental to your point-of-sale software package. At an absolute minimum, it should provide the following key features:

  • It should allow you to easily identify under-performing items that might benefit from looking at suppliers with lower order minimums.
  • You should be able to identify inventory items that are frequently over-stocked due to high order minimums.

We believe these tools will help you make the most of your investment dollars and increase your annual profits.

Learn more

If you’d like to learn more about inventory management, GMROI or point-of-sale software, please visit Paladin Point of Sale or call Customer Support at 800-725-2346.

Copyright © 2013 Paladin Data Corporation. All Rights Reserved.

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Printed on: 10/22/18