Turn/Earn Calculation and GMROI to Manage Inventory

The Turn/Earn Index and Gross Margin Return on Inventory (GMROI) are two simple ways to help manage your inventory.

Turn and Earn to manage inventory

Your purchasing manager or accountant may want to justify a SKU (stock keeping unit) with the Turn/Earn Index. Also known as the Turn/Earn calculation or Turn/Earn formula, or simply as Turn and Earn, it’s a simple way to help manage inventory by evaluating your entire inventory or a part number to see if it is worth stocking or selling.

To calculate the Turn/Earn index for your inventory, simply multiply gross margin x turnover (“turnover” is simply your inventory turns). For example, if your inventory turns 5 times in a year and you have a 35% margin your Turn/Earn index is 175 (35 x 5 = 175).

To calculate the Turn/Earn index for an individual part number or SKU, simply multiply gross margin x turnover (units sold per year). For example a product with a gross margin of 35% that sells 5 per year would have a Turn/Earn Index of 175 (35 x 5 = 175).

Companies typically look for a minimum Index of 100 to 150 although there are a lot of reasons for higher or lower numbers and a lot of it will depend on whether you are a manufacturer, distributor or a retailer.

A manufacturing company might shoot for a lower minimum index of 100 for an individual part number. Reasons might be that part number is required to support a broader product line, or it is necessary to support replacement parts or components, or it needed to address demand from specific market segments that might be new for the manufacturer.

A retail store might have a higher Index goal of 150 for a SKU. Reasons to have a higher Turn/Earn Index number might be limited shelf space, catering to a specialized retail market or the need to keep inventory down to conserve cash.

GMROI to manage inventory

Gross Margin Return on Investment, or GMROI, is another way to manage inventory. It takes into account the gross profit earned for each dollar of your investment in inventory. The calculation is (gross margin $$)/(average inventory investment $$). For example, let’s say your annual gross margin dollars, or your annual gross profit, is $250,000 and your average inventory value is $200,000, then your GMROI is 1.25 (sometimes GMROI is multiplied by 100, and in this case would be 125). GMROI is typically used by retailers or distributors to evaluate inventory and is less commonly used by manufacturers.

GMROI tells you how many dollars in gross profit are earned by each dollar in inventory. In the above example, for every $1 invested in inventory you’re producing $1.25 in gross profit.

GMROI measures inventory differently than the Turn/Earn Index and neither is “better,” just like 12 inches is not “better” than 30.5 centimeters (they’re the same length).

What is an “inventory turn?”

The traditional way to measure SKUs over time is by “turns,” or how many times the inventory turns over each year.

One long formula for inventory turns (written here in ‘Excel-friendly’ format) is:
(($ beginning inventory + purchases over a defined period – ending inventory)/(ending inventory)) x (number of time periods).
The number of time periods is typically 12 months.

A shorter formula to measure inventory turns (again, in ‘Excel-friendly’ format) is:
(Cost of goods from inventory over 12 months)/(Average inventory investment over 12 months).

Read about Financial Benchmarking

Use benchmarking to measure key performance indicators and compare your business against your peers. Hedges & Company manages the SEMA Financial Benchmarking program, a free member benefit for SEMA members. Learn about the SEMA Financial Benchmarking program here.

Another related article: read about how price increases/decreases and unit sales affect gross profit.

Tags: auto aftermarket industry, automotive aftermarket, automotive marketing, GMROI, Inventory management, strategic planning