Profitability ratios
Profitability ratios are commonly used to compare financial information to determine performance effectiveness. For example, inventory turnover measures the number of times that you sell a product in a year. It indicates how efficiently you use purchasing funds. The Product Administration ABC Inventory Evaluation Report overrides the standard method of classifying inventory.
GMROI
Gross margin is the value of sales minus the cost of goods sold. It is calculated for each line item. This calculation is used to find gross margin return on investment (GMROI) :
- Collective gross margin for all sales / Average Inventory at Cost
Average inventory at cost is calculated by the Product Administration Average Inventory Daily Calc Report.
The GMROI shows which products are profitable and which are not. You can use GMROI to identify the products that have relatively low sales but high revenue value. GMROI can also help you make stocking decisions.
For example, for a product with a small GMROI is a low profitability product with a low sales volume, you could stock this product in a centralized warehouse. If transportation costs are high, you could stock low-profitability products where the demand is the highest, or handle it as a nonstock or drop-ship product, instead of stocking it in your warehouse.
Sales
Because the money to pay operating expenses and purchase new inventory only comes in sales, sales volume is a measure of cash flow. A product’s contribution to sales is calculated with this formula:
- Total sales amount for the product / Total sales for all products in the warehouse
Quantity
This measurement can help to determine whether the product is located in a centralized warehouse or in a branch. For example, if the unit sales volume is high but the product yields a low margin, stock the product where the customer demand is. This measurement can also help you determine storage requirements and storage location. This formula is used to calculate the quantity profitability ratio:
- Total units sold for the product / Total units of all products sold in the warehouse
Override (Over) Classification
The override classification is an optional indicator of the importance of the product to a customer and the importance of that customer to your business. This classification relates to emotion, instead of concrete evidence, and it cannot be calculated by the computer. Most products do not have a override classification assigned, but you can assign a level to certain sensitive products to override the computer-generated levels assigned.
Because the override classification is based on inconsistent, biased data, you might stock more inventory than is required. Consider the other profitability ratios and frequently review the override classification level assigned. You can also assign an Override (Over) Expiration date.