Are You Capturing Your Costs? Do You Know Your Margins?

You can excuse cannabis entrepreneurs for focusing on regulation and taxation. But to understand their productivity and profitability, they need to focus more on cost accounting—that is, on understanding their actual costs in real time.

You can’t make money if you don’t know your costs. And if you don’t know your actual margins, you don’t know the value of your business. Manufacturers need a cost accounting model that gives them a precise understanding of all the elements involved in their manufacturing process. But most are incorrectly reporting their costs to manufacture their products on their financial statements.

Understanding your costs comprehensively is critical. If you don’t know how much it costs to make your product, you can’t know how to price it. Cannabis manufacturers must be able to compile all costs, starting at the beginning of their process, from buying the raw material, and walking through every step of their process. But many tend to overlook costs, such as overhead, including the costs associated with operating their facilities, and the cost of labor, including idle and down time. To ensure you are including all relevant costs, you need a cost accounting model. Only then can you determine your actual margins and profitability.

A cost accounting model will also reveal anomalies and inconsistencies. Once your standards are established and implemented in a model or system, you can identify variances from those standards—resulting from more employee hours than predicted, a change in the process, etc.—allowing you to determine reasons for inefficiencies that can then be addressed and resolved.

Understanding your true costs and margins in real time is critical to your valuation should you decide to sell or if you are applying for credit. A buyer wants first to know what they can expect in return on their investment (ROI). In the manufacturing space, gross margin, or gross profit, is the most critical component for determining ROI. Many cannabis manufacturers have been determining gross profit by estimating their gross margins. But if they inappropriately allocated costs to their cost-of-goods-sold, they sacrifice their margins, and therefore their valuations. It is another call for a viable, comprehensive, and expertly developed cost accounting system.

A cannabis entrepreneur must be able sit with a buyer or, if you’re borrowing, a creditor, and explain how your business makes money. Too often manufacturers don’t know their actual margins until well after their year-end accounting. Investors want to know your margins in real time, and with a cost accounting model established for your business, you can produce real-time financial statements.

There are no standardized cost accounting models for the cannabis industry. Given the federal legal status of our industry and the hesitancy of some banks to do business with our companies, many of the major accounting software providers have chosen not to accommodate the cannabis industry; some are treating the industry with hostility. HBK Cannabis Solutions is building customized cost accounting models for our cannabis clients. We detail the client’s manufacturing process and every cost component in that process for the client to enter their numbers into their model each month. The models are detailed to the point of individual SKUs, so the manufacturer can make decisions about production based on real-time knowledge of the margins for each of their products.

Cost accounting is critical to your profitability and your valuation. For more information or to schedule a meeting an HBK Cannabis Solutions professional, call us at (239) 263-2111 or email me at cmarrie@hbkcpa.com.