Cost Of Goods Sold As A Percentage Of Sales Formula Retail Inventory Turn and GMROI – Measuring Retail Inventory Productivity

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Retail Inventory Turn and GMROI – Measuring Retail Inventory Productivity

When I first meet a prospect, I occasionally talk about my best year as a buyer. That was the year I fell 2%. Don’t get me wrong, I did a lot of climbs over the years, but this was the year I did my best. I bought men’s knit shirts and boy, was it the year of knit shirts! It was one of those “duck for cover” times and my 2% drop could easily have been a 10% or 15% drop instead. If only I had been the buyer of the shirt!

It’s easy to measure retail success based on sales results alone. After all, this is the top line, the number that every trader looks at first thing on Monday mornings. And it’s just as easy to fall into the trap of thinking that as long as sales are ahead, everything else will follow. Most of the time, profitability and cash flow come directly from sales growth, but certainly not always. And what happens if the sale stops?

For almost every small retailer, inventory is the main generator of revenue, profit and cash flow. Inventory typically accounts for 70-80% of a small retailer’s financial assets. It only follows that sales, profitability and cash flow are directly related to a small retailer’s ability to manage its inventory productively.

The key to any trader’s success is to turn your inventory into cash as quickly as possible at the best possible markup, then buy more stock and turn it into cash as quickly as possible, and so on and so forth. It may be stating the obvious, but sometimes stating the obvious helps bring things back to their core.

Carrying unnecessary inventory can reduce profitability and cash flow in a hurry. Excess inventory not only ties up a lot of money, but also the day-in and day-out costs associated with that inventory. From the cost of financing that inventory, to the cost of discounts due to age and obsolescence, to the additional labor costs associated with moving it, packing it and putting it away, to unpacking it and putting it back on display, to moving it from one location to another. to another, because of the hidden costs of selling in lieu of more productive inventory, it all adds up and hits the bottom line every month, quarter, and year.

In its simplest form, retail inventory productivity can be defined as the amount of sales and gross profit dollars that an investment in inventory generates over a period of time, usually a year. And the most basic measures of inventory productivity are inventory turnover and gross return on investment (GMROI).

Retail inventory turnover

Inventory turnover answers the most basic questions; how many times was i able to cash my stock, buy more and cash it? It is not enough to know the sales volume or inventory level, it is important to relate sales to inventory investments. $1,000,000 in annual sales with an average inventory of $500,000 is one thing, but an average inventory of $200,000 is quite another! That’s the difference between turning over two and five times the inventory.

The formula for calculating inventory turnover is quite simple:

Sales (at retail price) / average inventory value (at retail price)

Alternatively, if your system carries inventory value only at cost, you can calculate inventory turnover as follows.

Cost of goods sold / average inventory value (at cost price)

Retail Gross Margin Return on Investment (GMROI)

Total return on investment answers the question: How many gross margin dollars did my inventory investment generate to cover all of my other business expenses such as payroll, rent, utilities, insurance, etc.?

Gross Margin Dollars / Average Inventory Value (at cost)

Or expressed as a percentage:

% of gross profit / average inventory value (in cost)

A couple of technical points about these formulas:

Both inventory turnover and GMROI measure the productivity of existing inventory, so sales made from non-inventory items such as special orders must be excluded from the calculation. Both inventory turnover and GMROI are indicated as annual turnover. However, the measured period does not necessarily have to be 12 months. In certain situations, especially seasonal items, inventory turnover and GMROI may be measured over a few months, with the result “annualized” for comparison purposes.

Average inventory at cost is usually calculated as the average of the closing inventory over the previous 13 months. It represents the beginning and ending inventory values ​​for the previous 12 months. Inventory Turn and GMROI are dynamic metrics as sales and inventory levels fluctuate. Although they are often calculated annually, to fully utilize them as dynamic marketing tools, they need to be measured on an ongoing basis quarterly or even monthly.

And some more thoughts on inventory turnover and GMROI:

Your Inventory Turnover or GMROI should be some magic targets. Every business is unique. While there may be industry trends for both inventory turnover and GMROI, each small retailer is unique in its customer bases, merchandise assortments, and vendor structures. The key is to measure your productivity so you know where you stand and then work to improve that productivity.

Once you’ve measured your productivity to establish a baseline and developed strategies to improve that productivity, you need to focus on implementing and executing those strategies. Invariably, small retailers that do not focus on improving the productivity of their inventory usually find their productivity declining. There is no such thing as standing still. If you don’t know you’re moving forward, you’re likely to go back.

This means not only reducing inventory, but also selling more with less inventory. Again, when small retailers focus on improving inventory productivity, they often focus on improving assortments and reducing inventory. But a funny thing usually happens in the process. They focus on where their sales and gross margin dollars actually come from, they make sure they have the right merchandise, at the right prices, in the right place, at the right time, in the right quantities, and their sales grow!!

And an afterword. Why was my 2% drop for the year my best ever? First, I saw it coming. Shopping at the market before the start of the season, it was pretty obvious that this just wasn’t going to be the year of knit shirts. Second, I had the benefit of a management team that wasn’t just focused on the top line, they were focused on the bottom line as well. While they would have preferred me to scale up, they were more concerned about my department being profitable and hitting my GMROI goal.

So what did I do? Well, with two strikes against you, there’s little point in swinging for the fences. I bought very little in advance, tested several different products in small quantities, but took few risks. I kept my range basic to appeal to the widest range of customers, knowing that fashionistas were heading straight for knitwear anyway. I kept my inventory low and avoided devastating discounts.

And my GMROI, that key measure of retail profitability? My best ever.

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