The Relationships Between Profitability, Inventory Efficiency, and Gross Margin Return on Investment in Alabama Community Pharmacies

Abstract

The results of a cross-sectional, ex postjucto study describing the relationships between profitability, inventory turnover, and gross margin return on investment in Alabama community pharmacies during fiscal year 1983 are presented. The objective of the study was to determine the relationship between gross margin return on investment and net profit. Based on a literature review of retailing, it was found that gross margin return on investment, GMROI, may bc useful as a predictor because of its comprehensiveness, ease of calculation, and acceptance as a proxy for profitability. GMROI is a ratio of gross margin as a percent of net sales multiplied by average inventory turnover. It has been referred to as an "earn and turn" ratio. Values between 150% and 250% have been reported as positively associated with profitability. GMROl and net profit were positively correlated (r = 0.5218, p< 0.001). Stepwise multiple regression was performed on all variables with net profit as the dependent variable. Gross margin return on investment for the prescription department, pharmacy gross margin, and prescription inventory turnover maximally predicted net profit dollars (R = 0.6450), accounting for 37.5% of the variance. A store-wide GMROI of at least 193% was essential for profitability. The study results give further evidence of the usefulness of GMROI as an indicator of management effectiveness. However, within the scope of community pharmacy operation, managers should monitor prescription department inventory cost and target gross margin, as GMROI in this area explained the most variance in the data with regard to profitability.