- Opening Month Inventory for an Item was 10 units at a total cost of 500 Rs. (unit cost : 50 Rs.)
- Closing Month Inventory for the Item is 4 units at a total cost of 200 Rs. (unit cost : 50 Rs.)
- The Item was being sold at 75 Rs. through out the period and total sold quantity was 6 units.
- The Vat rate for the item is 14 per cent (9.21 Rs. unit vat)
- The selling area provided for the product was 9 sq.ft stand
With the above business picture, we can look at a few formulae that can help us to do a business health check :
1. Weighted Average Cost (WAC) :
Weighted average cost is the average cost at which an item is held with the retailer based on history purchases. It is calculated based on the weightage of quantity purchased and the cost at which they are purchased. It keeps changing over the period based on the cost and quantity of goods received, hence it is also known as Moving average cost.
WAC = {(SOH x unit cost) + (IQ x unit cost of purchase)}/ (SOH+ IQ)
SOH - Stock on Hand
IQ - Incoming Quantity / In-transit Quantity / GRN quantity
For example if our SOH is 10 units as 5 unit cost and a new PO is being received for 5 units at 6 unit cost then the WAC will be calculated as follows :
WAC = {(10 x 5) + (5 x 6)}/(10+5)
= {50 + 30 } / 15
= 80 / 15
= 5.33 Rs.
Weighted average cost is the basis for all stock evaluations and capital expenditures in financials when the Retailer works on Cost Based accounting Method.
2. Gross Margin Percentage (GM) :
Gross Margin percentage is the percentage of profit made from selling a product at POS before Taxes. It is a very simple and effective formula to calculate the percentage of Margin made from the sales revenue minus the cost of goods sold
Gross Margin % = {(Selling Unit Retail - weighted average Cost) / selling Unit Retail} x 100
= (75 - 50)/75 x 100
= 25/75 x 100
= 33.33 % is the gross margin made from sales
3. Net Margin Percentage (GKM) :
Net Margin percentage is the percentage of profit made from selling a product at POS after Taxes. It is a very simple and effective formula to calculate the percentage of net Margin made from the sales revenue minus the cost of goods sold. Retailers highly depend on this margin percentage to set their Mark Up percentage. This is also known as Gate Keeper Margin (GKM)
Net Margin % = {(Net Unit Retail - weighted average Cost) / Net Unit Retail} x 100
where
Net Unit Retail = [Selling Unit Retail/(1+(vat rate/100))]
= [75/(1+(14/100))]
= [75/1.14]
= 65.79 Rs. is the net unit retail after tax
Net Margin % = (65.79 - 50)/65.79 x 100
= 15.79/65.79 x 100
= 24 % is the net margin made from sales after tax deductions
4. Gross Margin Return on Investment (GMROI)
This ratio helps retailers in particular Merchandisers, category buyers and investors to know what level of returns can be obtained upon the investment made for a stipulated time period. In simple terms it helps us understand the performance of a category/ item with respect to gross sales margins.
In financial terms this ratio will help us understand the rate of cash turnover upon inventory investment during a stipulated time period
GMROI = (Gross Margin value / Average Inventory Cost)
where
Gross Margin value= (Gross Sales value - Cost of Goods Sold)
Average Inventory
={(opening inventory cost of each month- Closing inventory cost of last month)/(No. of months+1)}
= (450 - 300) / {(500+200)/(1+1)}
= 150/350
= 0.43
GMROI % = 0.43 x 100 = 43% of the total cost of inventory held for the period
The above example shows that the Item is low on sales and high on inventory holding cost because we need to hold the inventory for a longer period of time to clear stock through sales.
another formula for GMROI is
GMROI = (Gross Margin% X Sales) / Average Inventory Cost
where Gross Margin= (Gross Sales - Cost of good Sold)/Gross Sales
How to improve GMROI ?
- Reduce holding inventory value and increase sales
- Do not excess order
- Maintain a stable Margin% based on fluctuation in cost
- Keeping your production cost or Procurement cost low
Benefits of GMROI :
- Gives visibility to actual gross profit made from selling a product
- Helps in differentiating your STAR , CASH COW and DOGS in your product line based on actual
margins made rather than sales value (Ref : BCG MATRIX)
5. Gross Margin Return on "Selling Area" / " Footage " (GMROS) / (GMROF)
This ratio explains the gross margin made by the product upon the selling area allocated for the product. This is used by retailers to find the gross margin per square feet in the selling area and take decision on expansion of selling area or reduce the selling area or discontinue the product all together
GMROS = (gross margin value/selling area)
= (Gross Sales value - Cost of Goods Sold)/selling area (in sq.ft)
= (450 - 300)/9
= 150/9
= 16.67 Rs / sq.ft
another formula for GMROS is
GMROS = (Gross Margin% X Sales) / Selling Area
Benefits of GMROS :
- Helps in space allocation of selling area as per the category performance
- Helps is designing shop floor planogram
- Helps is visual merchandising and changes is display area within the shop floor
How to improve GMROS ?
- Display the products at the right place within the shop floor eg. placing chocolates and gums near cash tills helps in reducing the display space and increase sales there by increasing GMROS
- Effective and easy access to products category wise to customers
- Reduce excess stacking of products on shop floor
6. Inventory Turnover :
Inventory turnover is a measure of the number of times inventory is sold or used in a time period such as a year
Inventory Turnover = Cost of Goods Sold / Average Inventory cost
= 300 / {(500+200)/(2)}
= 300 / {350}
= 0.86 is the inventory turnover for the month
The above Inventory turnover of 0.86 means the inventory has not been sold out even once.
Inventory turnover is also known as stock turnover
7. Stock Turnover Days / Average Days to Sell the Inventory :
The average days taken to sell the inventory for a particular stock Turnover level
Stock Turnover Days = No. of Days in Year / Inventory Turnover ratio
= 365 / 0.86
= 424 Days
424 will be the days taken to clear the inventory with above Inventory turnover level and average inventory level
8. Rate of Sale (ROS) :
Rate of sales percentage is the increase or decrease in sales percentage over a period of time.
This is a comparative figure, arrived at by comparing sales from two similar period in time.
For example month over month, year on year, week on week sales comparisons. It can be done at
cost, Retail or Quantity level
Rate of Sale = {(Current Period Sale - Previous Period Sale) / Previous Period Sale}x100
Lets take an example of an SKU which had sold 10 units in March 2014 and 8 units in March 2013.
Now to know the rate of sale :
ROS = {(10-8)}/8 x 100
= 2/8 x 100
= 0.25 x 100
= 25 % increase in Sales YOY for the month of March
Benefits of ROS:
- Helps in Identifying TOP selling SKUs
- Helps in identifying growth and decline in sales
- Helps in identifying the current status of the product in the Product lifecycle phase
How to improve ROS ?
- Proper availability of product all around the year
- Upgrading the quality and performance of the product on regular basis
- Ensure right product is available at the right time and sold at the right price
9. Return on Investment (ROI) :
It is the percentage to measure the performance of gains obtained from the total investment made in a product or total capital invested in a business. It will give clarity on how soon we can recover our investment cost or what percentage of profit we can expect from our investment.
For example: a food retailer has invested 2,00,00,000 Rs. to start his coffee Shop and after 1 year he has incurred an addition operational expense of 2,00,000 Rs. By year end he had total net gain after tax of Rs. 20,00,000
ROI = {Net Profit/Total Investment} x 100
= (2000000/20200000) * 100
= 9.9 % is the total investment recovered by Net Profits for the financial year.
With the current operational cost year on year, it will take around 10 Years to attain break even
10.Acid Test Ratio:
With this we will be able to find out the current status of the retail organisation i.e. the assets to liabilities ratio. This is one of the key parameters taken into consideration by investors, a simple health check of the organisation's financial status, this excludes the holding inventory value
Acid Test Ratio = (Current assets - inventory value)/Current Liabilities
10.Working Capital Ratio:
With this we will be able to find out the current status of the retail organisation i.e. the assets to liabilities ratio inclusive of the inventory value. This is a simple health check of the organisation's short term financial status, this includes the holding inventory value
Working Capital Ratio = Current assets/Current Liabilities
- Closing Month Inventory for the Item is 4 units at a total cost of 200 Rs. (unit cost : 50 Rs.)
- The Item was being sold at 75 Rs. through out the period and total sold quantity was 6 units.
- The Vat rate for the item is 14 per cent (9.21 Rs. unit vat)
- The selling area provided for the product was 9 sq.ft stand
With the above business picture, we can look at a few formulae that can help us to do a business health check :
1. Weighted Average Cost (WAC) :
Weighted average cost is the average cost at which an item is held with the retailer based on history purchases. It is calculated based on the weightage of quantity purchased and the cost at which they are purchased. It keeps changing over the period based on the cost and quantity of goods received, hence it is also known as Moving average cost.
WAC = {(SOH x unit cost) + (IQ x unit cost of purchase)}/ (SOH+ IQ)
SOH - Stock on Hand
IQ - Incoming Quantity / In-transit Quantity / GRN quantity
For example if our SOH is 10 units as 5 unit cost and a new PO is being received for 5 units at 6 unit cost then the WAC will be calculated as follows :
WAC = {(10 x 5) + (5 x 6)}/(10+5)
= {50 + 30 } / 15
= 80 / 15
= 5.33 Rs.
Weighted average cost is the basis for all stock evaluations and capital expenditures in financials when the Retailer works on Cost Based accounting Method.
2. Gross Margin Percentage (GM) :
Gross Margin percentage is the percentage of profit made from selling a product at POS before Taxes. It is a very simple and effective formula to calculate the percentage of Margin made from the sales revenue minus the cost of goods sold
Gross Margin % = {(Selling Unit Retail - weighted average Cost) / selling Unit Retail} x 100
= (75 - 50)/75 x 100
= 25/75 x 100
= 33.33 % is the gross margin made from sales
3. Net Margin Percentage (GKM) :
Net Margin percentage is the percentage of profit made from selling a product at POS after Taxes. It is a very simple and effective formula to calculate the percentage of net Margin made from the sales revenue minus the cost of goods sold. Retailers highly depend on this margin percentage to set their Mark Up percentage. This is also known as Gate Keeper Margin (GKM)
Net Margin % = {(Net Unit Retail - weighted average Cost) / Net Unit Retail} x 100
where
Net Unit Retail = [Selling Unit Retail/(1+(vat rate/100))]
= [75/(1+(14/100))]
= [75/1.14]
= 65.79 Rs. is the net unit retail after tax
Net Margin % = (65.79 - 50)/65.79 x 100
= 15.79/65.79 x 100
= 24 % is the net margin made from sales after tax deductions
4. Gross Margin Return on Investment (GMROI)
This ratio helps retailers in particular Merchandisers, category buyers and investors to know what level of returns can be obtained upon the investment made for a stipulated time period. In simple terms it helps us understand the performance of a category/ item with respect to gross sales margins.
In financial terms this ratio will help us understand the rate of cash turnover upon inventory investment during a stipulated time period
GMROI = (Gross Margin value / Average Inventory Cost)
where
Gross Margin value= (Gross Sales value - Cost of Goods Sold)
Average Inventory
={(opening inventory cost of each month- Closing inventory cost of last month)/(No. of months+1)}
= (450 - 300) / {(500+200)/(1+1)}
= 150/350
= 0.43
GMROI % = 0.43 x 100 = 43% of the total cost of inventory held for the period
The above example shows that the Item is low on sales and high on inventory holding cost because we need to hold the inventory for a longer period of time to clear stock through sales.
another formula for GMROI is
GMROI = (Gross Margin% X Sales) / Average Inventory Cost
where Gross Margin= (Gross Sales - Cost of good Sold)/Gross Sales
How to improve GMROI ?
- Reduce holding inventory value and increase sales
- Do not excess order
- Maintain a stable Margin% based on fluctuation in cost
- Keeping your production cost or Procurement cost low
Benefits of GMROI :
- Gives visibility to actual gross profit made from selling a product
- Helps in differentiating your STAR , CASH COW and DOGS in your product line based on actual
margins made rather than sales value (Ref : BCG MATRIX)
5. Gross Margin Return on "Selling Area" / " Footage " (GMROS) / (GMROF)
This ratio explains the gross margin made by the product upon the selling area allocated for the product. This is used by retailers to find the gross margin per square feet in the selling area and take decision on expansion of selling area or reduce the selling area or discontinue the product all together
GMROS = (gross margin value/selling area)
= (Gross Sales value - Cost of Goods Sold)/selling area (in sq.ft)
= (450 - 300)/9
= 150/9
= 16.67 Rs / sq.ft
another formula for GMROS is
GMROS = (Gross Margin% X Sales) / Selling Area
Benefits of GMROS :
- Helps in space allocation of selling area as per the category performance
- Helps is designing shop floor planogram
- Helps is visual merchandising and changes is display area within the shop floor
How to improve GMROS ?
- Display the products at the right place within the shop floor eg. placing chocolates and gums near cash tills helps in reducing the display space and increase sales there by increasing GMROS
- Effective and easy access to products category wise to customers
- Reduce excess stacking of products on shop floor
6. Inventory Turnover :
Inventory turnover is a measure of the number of times inventory is sold or used in a time period such as a year
Inventory Turnover = Cost of Goods Sold / Average Inventory cost
= 300 / {(500+200)/(2)}
= 300 / {350}
= 0.86 is the inventory turnover for the month
The above Inventory turnover of 0.86 means the inventory has not been sold out even once.
Inventory turnover is also known as stock turnover
7. Stock Turnover Days / Average Days to Sell the Inventory :
The average days taken to sell the inventory for a particular stock Turnover level
Stock Turnover Days = No. of Days in Year / Inventory Turnover ratio
= 365 / 0.86
= 424 Days
424 will be the days taken to clear the inventory with above Inventory turnover level and average inventory level
8. Rate of Sale (ROS) :
Rate of sales percentage is the increase or decrease in sales percentage over a period of time.
This is a comparative figure, arrived at by comparing sales from two similar period in time.
For example month over month, year on year, week on week sales comparisons. It can be done at
cost, Retail or Quantity level
Rate of Sale = {(Current Period Sale - Previous Period Sale) / Previous Period Sale}x100
Lets take an example of an SKU which had sold 10 units in March 2014 and 8 units in March 2013.
Now to know the rate of sale :
ROS = {(10-8)}/8 x 100
= 2/8 x 100
= 0.25 x 100
= 25 % increase in Sales YOY for the month of March
Benefits of ROS:
- Helps in Identifying TOP selling SKUs
- Helps in identifying growth and decline in sales
- Helps in identifying the current status of the product in the Product lifecycle phase
How to improve ROS ?
- Proper availability of product all around the year
- Upgrading the quality and performance of the product on regular basis
- Ensure right product is available at the right time and sold at the right price
9. Return on Investment (ROI) :
It is the percentage to measure the performance of gains obtained from the total investment made in a product or total capital invested in a business. It will give clarity on how soon we can recover our investment cost or what percentage of profit we can expect from our investment.
For example: a food retailer has invested 2,00,00,000 Rs. to start his coffee Shop and after 1 year he has incurred an addition operational expense of 2,00,000 Rs. By year end he had total net gain after tax of Rs. 20,00,000
ROI = {Net Profit/Total Investment} x 100
= (2000000/20200000) * 100
= 9.9 % is the total investment recovered by Net Profits for the financial year.
With the current operational cost year on year, it will take around 10 Years to attain break even
10.Acid Test Ratio:
With this we will be able to find out the current status of the retail organisation i.e. the assets to liabilities ratio. This is one of the key parameters taken into consideration by investors, a simple health check of the organisation's financial status, this excludes the holding inventory value
Acid Test Ratio = (Current assets - inventory value)/Current Liabilities
10.Working Capital Ratio:
With this we will be able to find out the current status of the retail organisation i.e. the assets to liabilities ratio inclusive of the inventory value. This is a simple health check of the organisation's short term financial status, this includes the holding inventory value
Working Capital Ratio = Current assets/Current Liabilities
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