Question

Below are data for four scenarios. Scenario 1 is the base scenario and the other 3 scenarios are modifications to the base scenario. Sales Cost of Goods Sold Gross Profit Scenario 1 Scenario 2 Scenario 3 Scenario 4 $10,000 $20,000 $10,000 $10,000 8,000 10,000 6,000 8,000 $2,000 $10,000 $4,000 $2,000 Average Inventory $5,000 $ 5,000 $5,000 $ 4,000 Required: Answer the questions below each question and use cell references for calculations. 1. Compute the gross margin percent for each scenario. Scenario 1 Scenario 2 Scenario 3 Scenario 4 Gross Margin Percent 20% 50% 40% 20% 2. Compute the inventory turnover for each scenario. Scenario 1 Scenario 2 Scenario 3 Scenario 4 1.60 2.00 1.20 2.00 Inventory Turnover 3. Compute the gross margin return on inventory investment percent for each scenario. Scenario 1 Scenario 2 Scenario 3 Scenario 4 Gross margin return on inventory investment 40% 200% 80% 50% Please answer Q4 and Q5 per above information 4. For Scenarios 2 through 4, explain what change occurred relative to Scenario 1 to cause the gross margin return on inventory (GMROI) to change. You need to specifically discuss each scenario change separately in comparison to scenario 1 by discussing the changes in the gross margin percent and inventory 5. Explain to management what type of factors influence the gross margin return on inventory investment. Included in your explanation, please included at least one outside reference to support your comments. Make sure you are providing detailed explanation, which cannot be completed with a one or two sentence response.

Answer 1

Sales COGS Gross Profit Scenario 1 Scenario 2 $10,000.00 $20,000.00 $ 8,000.00 $10,000.00 $ 2,000.00 $10,000.00 Scenario 3 Scenario 4 $10,000.00 $10,000.00 $ 6,000.00 $ 8,000.00 $ 4,000.00 $ 2,000.00 Average Inventory $ 5,000.00 $ 5,000.00 $ 5,000.00 $ 4,000.00 Scenario 3 Scenario 4 1. Gross Margin % = Gross Profit/ Sales Scenario 1 Scenario 2 Gross Margin percentage 20% 50% 40% 20% 2. Inventroy turnover = COGS / Average inventory Scenario 1 Scenario 2 Scenario 3 Inventory Turnover 1. 60 2 .00 1.20 Scenario 4 2.00 3. Gross margin return on inventory = Gross Profit/ Average inventory Scenario 1 Scenario 2 Scenario 3 Scenario 4 Gross Margin return on inventory 40% 200% 80% 50%

4.Gross margin return on inventory shows how much profit inventory sales produce after covering inventory costs. Gross margin of return on inventory = Gross margin percentage / Average inventory. So GMROI will increase as Gross margin % increases and will decrease as Average inventory increases and viceversa. Now as we see compared to scenario 1, Gross margin percentage has increased (more than doubled) in scenario 2, while the average inventory costs remained the same. This has caused the massive increases in GMROI for scenario 2 when compared to scenario 1. On the same note, in scenario 3 also the gross margin percentage has increased (doubled) when compared to scenario 1, while average inventory remained the same. Now if we compare scenario 4, gross margin percentage is same as scenario 1, however the average inventory cost has decreased, This has caused increase in GMROI of scenario 4 when compared to scenario 1.

5..Gross margin return on inventory shows how much profit inventory sales produce after covering inventory costs. It will focus the investors attention on the return on inventory (or investment) rather than just sales profit. The factors that influence GMROI directly are the gross profit and average inventory cost. Further many other factors like Sales price, sales quantity, inventory purchase costs, inventory handling cots etc. will effect indirectly on GMROI, as these are factored into the direct effecting values. Now lets take an example on why to use GMROI.

Lets say I am a retail seller of Shoes. On January 1st 2020 I purchased 500 pairs of shoes at $10 per pair as inventory. During the year I was able to sell 100 pairs of shoes at $15 per pair. My closing Inventory will be 400 pairs at $10 per pair. So my

Sale for year = 100 x $15 = $1,500

Opening Inventory = 500 x $10 = $5,000

Closing Inventory = 400 x $10 = $4,000

Average Inventory = ($5,000 + $4,000) / 2 = $4,500

Gross Profit = ($15 - $10) x 100 = $500

GMROI = $500 / $4,000 = 12.5%

Now if you look at the above example, Do I have any cash with me, on year end? No. I paid $5,000 to purchase shoes and sale made during year is only $1,500. So at the year end i did not make any cash even though i made a gross profit. So gross profit is misleading.

Now what if i had purchased only 100 pairs of shoes.

Sale for year = 100 x $15 = $1,500

Opening Inventory = 100 x $10 = $1,000

Closing Inventory = 0 x $10 = $0

Average Inventory = ($1,000 + $0) / 2 = $500

Gross Profit = ($15 - $10) x 100 = $500

GMROI = $500 / $5000 = 100%

I would still have made the same profit in this scenario and my cash balance after paying for purchase would be $500 at the year end. This is because my cost of inventory is lower as I purchased only how much is required. So managers should focus on GMROI rather than just gross margin, to make sure that you are not over stocking. A GMROI above 100% is a positive sign.