Key Metrics to Measure Inventory Management Success
Turn Earn Index and GMROI

If a company enjoys high gross margins, it can be successful with lower inventory turns. Many companies that sell goods being liquidated justify keeping items in their warehouse for years, because they bought the material for pennies on the dollar and will eventually sell some of it for a premium. The Turn/Earn Index (T/E Index) will help you balance turnover and profits. It is calculated by multiplying inventory turns by the gross margin percentage. It highlights situations where high margins can compensate for low inventory turns.

Say, for example, you turn over inventory of an item four times a year and earn an average 30% gross margin on each sale of the product. That’s a T/E Index of 120. You get the same return on investment value if you turn the inventory of an item only twice but make an average gross margin of 60% on every sale:

2 turns  60% average margin = 120 T/E Index

On the other hand, the stock of a product with an average margin of 20% must turnover six times in order to achieve the same 120 T/E Index. The higher the T/E Index, the better! Most of our clients strive for a T/E Index above 120.

Gross Margin Return on Investment (GMROI)

A similar measurement to the Turn/Earn Index is Gross Margin Return on Investment (GMROI). GMROI also measures the profitability of your investment in inventory. It is calculated by dividing gross profit dollars from sales in the past 12 months by the average inventory investment over the same time period:

Gross Profit Dollars from Past 12 Months ÷ Average Inventory Value

For example, if you earned $20,000 in gross profits from an average inventory investment of $10,000, your GMROI would be 2.00 ($20,000 ÷ $10,000 = 2.00). By convention, like baseball batting averages, both the T/E Index and GMROI are often reported without two decimal places. In this example, the GMROI is 2.00 though most business people will refer to it as a GMROI of 200. This mean that you are earning $2.00 each year for every dollar of your average inventory investment.

Please note that while the Turn/Earn Index and GMROI both measure profitability, they do so based on two different scales (sort of like Fahrenheit and Centigrade temperatures). Compare the calculated T/E Index and GMROI using the following data:

12 Month Sales Dollars $20,000
12 Month Cost of Goods Sold Dollars $16,000
12 Month Gross Profit Dollars $4,000
Gross Margin ($5,000 ÷ $20.000) 20%
Average Inventory Value $2,000
Turnover = ($16,000 ÷ $2,000) 8.0 Turns per Year

T/E Index = 8.0 * 20% = 160
GMROI = $4,000 ÷ $2,000 = 200

Because they utilize different scales, the GMROI will always be greater than the corresponding T/E Index. Where 120 is a typical minimum goal for the T/E Index, most distributors strive for a GMROI above 150.