Author: ryan

It is essential that cannabis business owners understand the importance and value of their operational data. Whether it is the yield per plant for cultivators, THC content per batch for processors, or the average sale per customer for dispensaries, gathering and interpreting operational data is imperative to the success of every cannabis business. Like operational data, financial data plays a critical role in any major business decision. The combination of financial data and operational data summarizes the business’s performance and is key to understanding the business’s financial health.

Due to the fast-paced and dynamic nature of the industry, cannabis business owners often view the accounting function as an afterthought.  However, proper accounting is critical to prevent risks to an operations’ assets. Accounting is the source of obtaining the best results from financial reports and should be considered an integral part of operations.  The fundamental accounting functions are collecting, managing, and interpreting financial data.

Cannabis business owners can implement several tactics to guide them, improve their processes, and enhance the results within their accounting function.

Tracking Workflows: Precisely Understand How Much Money You Have, and How it’s Being Spent

The first step in collecting accurate financial data is to understand the workflows within your cannabis business. Workflows will outline how money is being received and spent. Identifying where money is coming in, or ‘cash inflows,’ and where money is leaving your business, your ‘cash outflows’ translates to each accounting function.  For example, cash outflow for packaging expenses relates to accounts payable, inventory, and cost of goods sold. This workflow can be traced to operations. In this case, packaging expenses were likely ordered by the packaging manager, who can identify how orders are placed and how bills are received.

Identifying Areas to Improve by Creating, Defining, and Adjusting Processes

After beginning to track and measure workflows, processes should be created to collect and submit the data to the accounting software. As cash inflows and outflows are continually monitored, identify opportunities to improve the operational workflow. Department managers should communicate with accounting departments to ensure operational data is collected and reviewed alongside financial data.

To use the same packaging expense example above, the packaging manager should be instructed to submit purchase orders prepared by accounting.  When goods are received, the packing slips and invoices should be provided to accounting to be applied to the open purchase. It is essential to identify how often the process should be performed within departments. In addition, inventory controls, such as purchase approvals, the review process for financial and operational data, and the process to retain supporting records, should be reviewed frequently.  Digital copies of all bills, receipts, sales, and invoices, should be retained and included with the corresponding transactions in the accounting software. Audits are a recurring theme for the cannabis industry, and cannabis business owners should be diligent in maintaining updated records.

Developing and Implementing Cannabis-Specific Accounting Policies to Accurately Measure Business Activities

Cannabis accounting is entirely different than any other industry and includes many additional steps and techniques.  It is imperative to understand the implications of various federal and state tax codes and cost accounting methods, which can vary depending on the business activities. Cannabis businesses should structure their accounting policies in accordance with their tax and costing approach.  The chart of accounts should be aligned with the accounting policies, and methods to track workflows should be established within each department, such as cultivation, extraction, packaging, etc. If the operation has multiple locations performing similar operations, tracking business functions by location within each department is highly recommended.  Comprehensive policies will be the guidance for the application of the financial data processed in the previous concept.  If cannabis business owners are unsure of the cannabis accounting methods that apply to their specific cannabis operation, do not hesitate to reach out to us.

Building a Monthly Reporting System to Gain Operations Insights

The ultimate goal for the cannabis business accounting function is to obtain sufficient information to make informed business decisions, reduce risk, and increase the bottom line. This can be accomplished by working with accounting to develop and implement a monthly reporting package. This process will summarize the financial data and provide insights into the cannabis business’s activities. A consistent monthly reporting package will enable management to analyze performance, develop key performance indicators, establish budgets, and forecast cash flow.  Management should always have access to this essential information, and it is critical that potential investors and lenders have access to this data as well.  Furthermore, this information should be readily available to assist in the management of the cannabis business.  Accounting can further customize reporting to the business’s specific target market and users.

Final Recommendations

Building a robust accounting function and implementing comprehensive policies is recommended from the inception of a cannabis operation. These vital steps provide management with the necessary tools to make data-driven, strategic decisions. In addition, thorough accounting policies will prevent issues in the long run. Whether a startup with limited resources or a well-established cannabusiness, we recommend consulting with cannabis industry experts to get the most from your financial data.

As advisors serving the cannabis industry since 2009, Bridge West Consulting serves more than 600 cannabis clients, including cultivators, processors, transporters, dispensaries, management, and intellectual companies, throughout the United States. Our clients rely on our cannabis expertise to maintain their financial data so they can focus on their growth and operations. Reach out, we’d love to talk.

Operating a cannabis or hemp cultivation and processing facility comes with significant challenges, including maintaining compliance with local, state, and federal laws. Due to the complex nature of the cannabis industry, operators also face many accounting and cash flow management challenges.

Lack of Historical Industry Data

Legacy accounts do not exist in the cannabis or hemp industries,. There is a lack of legacy accounting software that operators can use to track inventory costs year-over-year.  Currently, most states mandate the use of seed to sale software specifically designed to comply with state regulations.  Although this industry-specific software serves a critical purpose, it is not intended to support cash flow management. As an example, typically seed to sale software does not track production activity and determine plant growing costs, the price related to the yield, or the cost of the yield converted into a gram of oil.  It also does not help with supply chain management, which is crucial for any manufacturer.

IRS 280E Tax Code Hurdles

Until the Federal government removes cannabis as a Schedule I drug from the Controlled Substances Act, cannabis cultivators and processors remain subject to 280E, which prohibits deductions of anything otherwise ordinary and necessary. 280E only allows cannabis businesses to deduct the costs of goods, according to Section 471(c).  However, Generally Accepted Accounting Principles (GAAP) will allow cultivators and processors to allocate more costs into production costs, thus making up the costs of goods sold (COGS).  Unfortunately, this is difficult due to the absence of legacy accountants to help determine what meets the definition of 471(c) and GAAP.

Setting Up Your Cannabis Business for Financial Success

With the guidance of a skilled cannabis tax advisor, cultivators and processors can mitigate the pitfalls of 280E through GAAP accounting and meet the IRS requirements. It is critical to work with an advisor who has industry expertise and insight into the Federal and State’s interpretation of 280E and 471(c). To increase cash flow while mitigating the risk of noncompliance, it is essential to correctly set-up your accounting system from the beginning with the best chart of accounts and determine your departments. This initial step helps you understand the flow of inventory costs throughout the accounting system.  The next step is to understand each business transaction clearly and determine the type of expense, i.e., if it is a manufacturing expense and which department incurred the costs.  Cannabis business owners and operators must decide how to allocate expenses to each department, and examples are rent, utilities, and insurance.  In addition, it is vital to set-up your payroll to track labor by department.

Tracking Production Information to Develop Accurate Reports

Although most seed to sale software can collect some production information, the most reliable data is typically stored by department managers for cultivation, processing, and packaging. This is because most seed to sale software is designed to keep cannabis businesses compliant. Most departments will track their own production information and accounting departments should work closely with department managers to obtain critical production information. Developing meaningful production reports is challenging and requires communication across various areas of the business.  Obtaining accurate data for each aspect of your business is critical for accounting to review the cost of each department in relation to the product production. This information helps department managers and the accountants understand the costs at each stage.

Due to a lack of solid accounting systems that provide management with inventory reports, it is common to see significant growth in inventory levels, especially in yield and stock/bulk oil.  In a given year, a higher level of production will result in a better margin, but will not increase cash flow.  When gross profits are higher, cannabis operations must pay more Federal and State income taxes.

For cultivators and processors to increase cash flow, management, department managers, and internal accountants must understand the annual costs by department, the sales by product type, and the current inventory levels.  On a quarterly basis, if not more frequently, accounting departments should review production data to ensure it is accurate and consistent.  Bridge West works closely with owners and operators to mitigate compliance risks and increase cash flow.  Our deep industry experience allows us to make the process more manageable for department managers, internal accounting personnel, and management.  Reach out, we’d love to talk.

All sound business plans include financial projections and creating a meaningful and effective financial projection is both an art and science. A financial projection is a critical component in the cannabis licensing application process and will serve as an effective guide as cannabis operations expand. Logical financial forecasts help track your business’s monthly progress and accurately measure your business’s performance in comparison to your projections. A financial forecast  includes projected sales, budgeted expenses, a balance sheet, cash flow, and sources and uses of funds. In addition, a financial projection helps determine the necessary amount of funding and the projected return on investment (ROI).

How are Financial Projections Developed?

Cannabis operators face significant challenges in creating financial projections due to a lack of historical data or industry benchmarks.  For businesses in other industries, like manufacturing or construction, benchmark information can be obtained from third party financial data service providers. However, third-party providers that gather and sell financial information most likely have little historical data on the cannabis industry compared to traditional industries.

While cannabis companies are on the Canadian Stock Exchange, many are consolidated operations of vertical, distribution, and dispensaries, making them difficult to analyze. Therefore, financial plans for cannabis businesses are largely based on assumptions. An effective approach to developing a financial projection is to assess the current marketplace and measure data related to financial trends and growth opportunities. An additional strategy to gather sound financial data is to evaluate your current or predicted competition. Although the costs in your financial forecast will be unique to your business, assessing the current market and your competitors can help establish practical goals and objectives, and determine the growth opportunities in the market.

Effective Financial Projections are Ever Evolving

The explosive growth of the cannabis and hemp/CBD industries has increased the importance of sound financial projections. Whether your cannabis operation is a start-up or well established, effective financial projections should not be static.  On a regular basis, it is beneficial to reevaluate your operation’s sales forecast, budgeted expenses, balance sheets, statement of operations, and cash flow statements. Aligning your financial projections and business goals is essential to developing a solid foundation for financial and operational success.

The Benefits of Working with a Cannabis Industry Expert

When developing a business plan with a financial projection for the purpose of securing funding or a cannabis license, it is highly recommended to have a trusted advisor who specializes in the cannabis industry prepare your financial plans.  At Bridge West, a key advantage in helping our clients build solid financial projections is the data we collected over the last ten years of serving the cannabis and hemp/CBD industries. Our data is categorized by type of operator: vertical, cultivator, processor, distributor, delivery, dispensary, or retailer.  In addition, our data is organized by markets, ranging from limited competition to over-supply, such as Oregon and Colorado. This is beneficial for operators developing or modifying a financial projection, since we can quantify the specific costs within a forecast. As an example, we quantify the plant yield and cost per yield for a cultivator that grows indoor vs. greenhouse vs. hoop house vs. outdoor. These analyses are very helpful in making educated decisions and strategic planning.

In a projection, a common error that we find is the amount of working capital needed, and the working capital is typically under-estimated. We apply our analyses of similar cannabis operations to facilitate education decision making and strategic planning. Therefore, a precise estimate can be made to identify the amount of working capital needed for inventory for each type of operator.

Financial projections should generally reflect five years of balance sheets, statement of operations, and cash flows. Generally, a detailed forecast of operating expenses should be developed by department and for at least two years. The most reliable financial forecasts are often built by trusted cannabis advisors working with management and operators. Ultimately, financial forecasts should become a measurement tool for a cannabis operation that is constantly analyzed and evolving.

If you have any questions or are interested in learning more about how we can help your cannabis operation build a financial projection to support your business plan, reach out. We’d love to talk.

Typically, state tax authorities will let cannabis businesses know if they have not paid enough sales and use taxes. However, will they notify you if you’ve paid too much? The odds are slim. The possibilities are so unlikely that cannabis owners and operators often hire tax experts to perform reverse audits to identify overpayments so they can request refunds.

Understand the Available Tax Exemptions

It is essential for cannabis businesses to understand the sales and use tax exemptions available to them. For example, most states offer companies exemptions from sales tax on machinery, supplies, and tools used to manufacture products.  Generally, state tax laws also do not require businesses to pay taxes on the utilities and materials used in the manufacturing process. Cannabis businesses may be able to take advantage of some of these sales and use tax exemptions. Operators need to understand their state’s specific tax laws and claim the proper available exemptions; otherwise, exemptions to which you are entitled may be missed.

Traditional businesses often utilize sales and use tax compliance software to safeguard against overpaying; however, there are limited systems designed specifically for the cannabis industry to alert businesses of overpayments related to manufacturing. Overpaying can result from many reasons, including staff turnover, business expansion or downsizing, and human error mistakes, and can have significant consequences.

Review Broad and Historical Data

Reverse audits typically reach every department within the cannabis businesses and date back to the statute of limitations on state tax reviews. To ensure a reverse audit is accurate and effective, the auditor should review as much historical data as possible. For example, if a state auditor can review financial records for the four years preceding the audit, the reverse audit should comprise the same timeframe.

Common Types of Tax Overpayments

Two prevalent types of tax overpayments are on components of manufactured products and on the equipment used to make the products. Other areas where overpayments may occur, depending on state laws, include:

• Manufacturing equipment,
• Pollution control equipment and supplies,
• Safety equipment,
• Warehouse equipment,
• Software licenses,
• Maintenance fees,
• Protective clothing, and
• Service transactions.

If you believe your cannabis organization has overpaid on sales and use taxes in these and other areas, it is essential to clearly understand your operations. For example, to ensure that you are receiving maximum benefit from industrial processing exemptions, you must know where your manufacturing process begins and ends.

The Process – and Three Phases – for a Reverse Sales Tax Audit

Phase One: Feasibility Study

The first phase in a reverse sales tax audit is to perform a feasibility study, which analyzes various financial and accounting functions within a cannabis business. The results of a feasibility study help operators identify and estimate the potential sales/use tax refund opportunities. Depending on the size of the company, this may require up to two days of review. This first phase of the reverse audit typically reviews a fixed asset listing, chart of accounts, accounts payable detail for selected reports for a sample period, and invoices.  If available, the auditor would also review an electronic download of all invoices and accounts payable activity. The feasibility study may only cover a certain period, where the results are projected over all time periods within the statute of limitations. Then, the auditor would estimate the potential refund.  Depending on the results of this phase, the auditor will determine the next steps to take in phase two, the validation phase.

Phase Two: Validation

If the auditor identifies an overpayment in phase one, ‘the feasibility study,’ the primary focus of the validation phase is to compile the documentation required to prepare and submit the claim for a refund. The auditor will usually meet with the department managers who are most familiar with the items purchased, i.e., plant supervisors or buyers, to provide descriptions of the claimed items. If the reason for the exemption would not be evident to the state’s claim reviewer, department managers may be required to submit summary explanations. Once the proper documentation is compiled, the final step during the validation phase is to present the entire refund claim package to the company for review and approval.

Phase Three: Coordinating with the State and Ensuring the Refund is Issued and Received

Once the cannabis business approves the refund claim package, it is submitted to the state. It is common for state representatives to respond with questions and requests for copies of invoices. Accordingly, phase three includes responding to the state’s requests and ensuring that the refund is issued and received by the cannabis business. Similar to the final step when mitigating an exposure, it is crucial that department managers and other company personnel are trained to capture the exemptions that resulted in the prospective refunds.

Save Now and Later

Although the reverse audit process is time-consuming and complex, the end result can produce a significant financial gain for cannabis businesses. Each state’s rules and regulations for sales and use tax refunds are complicated. However, an experienced cannabis tax advisor can properly prepare a cannabis owner’s refund claim before they are officially submitted to the state for review.

Since 2009, Bridge West has assisted cannabis operations with reverse audits and successfully helped clients reap tax refund rewards now. We also work closely with owners and operators to update compliance systems and implement tax minimization strategies.  Reach out, we’d love to talk.