Gross margin represents the proportion of the dollars a company receives as revenue that actually goes toward gross profit. Return on investment is a measure of investment profitability. Gross margin return on investment (GMROI) is a combination of the two calculations. It helps apparel retailers analyze each product's gross margin as it relates to the investment the retailer makes in inventory, shifting the focus away from sales numbers alone as a measure of success. This helps decision-makers focus on profitability per product rather than by department and helps them single out catalog offerings that are not performing well.
1. Figure the gross profit margin per product. Subtract the cost of goods sold from the product's total sales revenue. For example, a pair of designer jeans is priced at $150 and costs $75 to produce. The retailer sells 10 pairs of jeans for total revenue of $1,500. The calculation is $1,500 minus $750 = $750.
2. Compute the average cost of inventory for the product. Add the opening inventory figure for a given period to the closing inventory figure, then divide the result by 2. For example, the opening inventory for the jeans is $5,000 and the closing figure is $3,500. So, $5,000 plus $3,500 equals $8,500. $8,500 divided by 2 equals $4,250.
3. Divide the gross margin figure by the average cost of inventory to arrive at gross margin return on investment. Continuing with the example, $750 divided by $4,250 equals $0.17 GMROI.
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