Costs of inventory include the replenishment costs: purchasing and transferring, receiving, handling, transportation and accounts payable. Carrying costs include storage, insurance, security, perhaps spoilage or obsolescence. Replenishment and carrying costs typically combine to add another thirty percent to the total cost of inventory each year.
Turns per year (COGS / average inventory) is a crucial measure of effective inventory management. Is an item purchased for $0.98 and sold for $1.00 worth stocking? That depends on how fast it turns. If it turns seventy times, then it's worth stocking. Seventy times $0.02 divided by $0.98 is 143 percent. The GMROI is $1.40 for a $0.98 investment. This is one of three common ways to calculate GMROI.
A GMROI more than 130 percent will likely be profitable. Items that turn quickly can have low margins. Items that turn slowly must have high margins. Items with a GMROI of less than 100 percent do not even earn back the cost of being stocked. Items with a GMROI more than 200 percent might be a cause of lost sales to the competition. Reasons for low GMROI can include excessive discounting or improperly priced customer return and allowance policies.
A distribution system should affect GMROI by holding fulfillment at target levels while increasing turns and decreasing transfers and buys from the competition. A general accounting package, by contrast, will likely lack the required inventory management features.