Turnover and margin by category: where money works

The turnover ratio shows how fast goods sell, but not how much profit the money invested brings. Drinks turn over very fast, yet each so'm of sales leaves very little margin. Cosmetics turn over slowly, but their margin is high. To decide which category deserves more money you have to look at speed and income together. This is what GMROI is for: gross margin ÷ average inventory (at cost). It shows how many so'm of margin each so'm invested in stock brings in a year.

How to calculate it

You need annual figures by category: sales, cost of goods and average inventory. Gross margin = sales − cost of goods. Take average inventory not from the year-end balance but as the average of month-end balances: in a seasonal category the year-end balance distorts the picture. Value stock at cost, not at selling price, otherwise the ratio is distorted from both sides. Finally, check that the category margins add up to the total margin and the category inventories to the total inventory. If they do not, some item sits in the wrong category or has no category at all.

Example: four categories

In millions of so'm, for one year:

• Household chemicals: sales 600, cost 480, average inventory 60. Margin 120, turnover 480 ÷ 60 = 8.0, GMROI 120 ÷ 60 = 2.0.
• Drinks: sales 900, cost 810, inventory 54. Margin 90, turnover 15.0, GMROI 90 ÷ 54 = 1.67.
• Cosmetics: sales 400, cost 260, inventory 130. Margin 140, turnover 2.0, GMROI 140 ÷ 130 = 1.08.
• Household appliances: sales 500, cost 400, inventory 100. Margin 100, turnover 4.0, GMROI 1.0.

In total, sales are 2 400, cost 1 950, margin 450 and inventory 344. Overall turnover is 1 950 ÷ 344 = 5.7 and GMROI is 450 ÷ 344 = 1.31.

Reading the result

Drinks turn over fastest (the stock lasts about 24 days), but by GMROI chemicals overtake them: 2.0 against 1.67. Cosmetics have the highest margin, 35 percent, but the goods sit for 183 days on average, so GMROI is only 1.08. Appliances come last with 1.0: each so'm put into stock brings just 1 so'm of margin a year.

Compare the share of money in stock with the share of margin. Cosmetics occupy 37.8 percent of the money in stock and give 31.1 percent of the margin. Appliances take 29.1 percent of the money and return 22.2 percent of the margin. Chemicals, with 17.4 percent of the money, generate 26.7 percent of the margin. This comparison shows where money should be moved.

How the decision follows

The rule is simple: cut stock in a category with low GMROI and expand it in one with high GMROI and growing demand. Suppose cosmetics can drop stock from 130 to 100 million so'm while keeping sales and margin. GMROI rises to 140 ÷ 100 = 1.4, and the 30 million so'm released go to chemicals or another well-performing category. The reduction can come from the slowest positions and from needlessly deep safety stock.

Once the decision for a category is made, go down to the level of individual items. Sort cosmetics by the value of stock and draw up two lists: items that have not sold in the last 90 days, and items whose turnover is below the category average. Start the reduction with the most expensive items on these lists. Do not stop ordering all at once: first lower the reorder point, then run the existing stock down through sales and check the result with GMROI after three months.

What to watch out for

• A low-margin product such as drinks brings customers in. Do not drop it solely because GMROI is low; judge it together with customer traffic.
• Gross margin usually excludes shortages, returns and holding costs. In a category where they are large, the real profit is smaller.
• If a category is too broad, differences inside it disappear. In the largest categories look at the A-group items separately.

Conclusion

Turnover shows speed, margin shows income, and GMROI combines both in one number. For the calculation to be right, balances and costs must be reliable. CountLab confirms balances through stock counts, singles out the most important items within a category by ABC/XYZ analysis, and shows stock and margin side by side in the management report.