How to Increase Cash Flow for Cultivators and Processors
CannaBlog By Cory Parnell, CPA, COO of
Bridge West CPAs and Advisors to the Cannabis Industry
There are many challenges in operating cannabis and hemp cultivation and processing facilities, including state, local and federal compliance. There are also many challenges when it comes to accounting and managing cash flow for cannabis and hemp cultivators and processors.
First, there are no legacy accounts in the cannabis or hemp industries. In addition, there is no legacy accounting software that operators have used in the industry to help track inventory costs over a period of years. The seed to sale software mandated in most states is designed to meet specific state compliance regulations. This software is not designed to track production activity and assist in the determination of costs for the plants growing, cost related to the yield or cost of the yield converted into a gram of oil. Also, it does not help with the supply chain management, which is crucial for any manufacturer.
Cannabis cultivators and processors are subject to 280E, which only allows you to deduct the costs of goods, according to Section 471. The use of generally accepted accounting principles (GAAP) will allow cultivators and processors to allocate more costs into production costs, which make-up the costs of goods sold. Again, with the lack of legacy accountants to help determine what meets the definition of 471 and GAAP, this becomes challenging.
Bridge West has helped hundreds of cultivators and processors over the past ten years with accounting and meeting the IRS requirements by using GAAP accounting. Also, we have been through three dozen Federal and State 280E audits, which provides us with some insight of Federal and State’s interpretation of 280E and 471. The key is correctly setting up your accounting system from the beginning with the best chart of accounts and determining your departments. This is essential because it helps you understand the flow of inventory costs throughout the accounting system. The next step is to gain a clear understanding of each transaction and make a decision if this is a manufacturing expense and which department incurred the costs. Decisions need to be made related to allocating expenses to each department and examples are rent, utilities, and insurance. In addition, it is important to set up your payroll to track labor by department.
The most important area is for accounting to work with the department managers for the cultivation, processing, and packaging. Some production information can be gleamed from the seed to sale software, but most of the department managers will track their own key production information. This is because getting meaningful production reports is very difficult. Again, most seed to sale software is made to make sure you are compliant. Accounting must work with the department managers to review the cost of their departments in relationship to the product production. This helps the department managers and the accountants understand costs at each stage.
Because there is not a good accounting system that provides management with inventory reports, we will normally see a significant growth on inventory levels especially in yield and stock/bulk oil. The higher the level of production in a year will show better margin but does not help with cash flow. This is because the higher the gross profit, the more federal and state income taxes will be paid.
It is important that management, department managers, and internal accountants understand the annual costs by department, what is the sales by product type and current inventory levels. This should be reviewed at least quarterly to make sure everyone is on the same page. At Bridge West, we continuously work with management, department managers, and internal accounting personnel in making this very challenging area more manageable.
For additional information on this topic, please listen to our recent webinar and contact Cory Parnell at firstname.lastname@example.org with any questions and for a review of this matter with your team.