Highlights of the April 8, 2022 webinar hosted by Christopher Marrie, Director HBK Cannabis Solutions, and Warren Harasz, VP of Compliance, Cannaspire

As the cannabis industry grows and matures, better practices in operations and costing are necessary to remain competitive, balance quality with compliance needs, and keep your organization ready for long-term objectives, such as exits, expansion, and sustained profitability.

Webinar content includes:

• How to better identify commonly overlooked cost savings opportunities in your cultivation’s operations

• Achieving the goals of product quality and product compliance without sacrificing one for the other

• Lowering unexpected tax and compliance risks with better systems and SOPs

• Effective and time-efficient costing methods to identify inefficiencies and make better decisions than your competition

General cultivation costing issues

For cultivators in startup mode

• New Jersey is the most active state on the East Coast in licensing

• Key is being involved in the municipalities where you will be located; will need their verification to get licensing; attend municipal meetings

• Due to IRS rules on deductions for cannabis companies, you will not be able to deduct costs you incur getting licensing; also remember that in the pre-revenue stage, you can only deduct your cost of goods sold (COGS)

• IRS has mandated using full absorption GAAP accounting for your COGS, and your books must match your tax return in terms of accounting method.

• Some companies strategize positions like an agriculture business to stay out of the plant-touching side of the business as long as possible before they are licensed and ready to begin operations.

• In terms of startup costs, you can start small and build your way up easier with an outdoor facility. Indoor facilities, typically for mass distribution, are more costly. For example, some New Yorkers are converting CBD farms convert to cannabis licensing at minimal costs. Cost to get an outdoor product up and running may be limited to securing the license, start tracking as required, the labor to run it, and some marketing initiatives. Indoor involves a lot more moving pieces through facility which affects costs.

• Seed-to-sale software won’t suffice for tracking, like yield per strain, yield per square foot, cost per gram. None of that will be covered by seed-to-sale software.

• The overhead of the facility, while you’re ramping up, is COGS.

• Better to start with reasonable realistic production projections: under promise and over deliver. Need to anticipate startup cost through the entire life-cycle of the plant: ultimately an entire life cycle of 60 to 70 days through harvest, plus time to produce those clones, then the labor for the flip.

• There is going to be some period of trial and error where costs will be greater than anticipated. It takes two or three harvests in the indoor space.

• Have to track and quantify costs or you can’t make good business decisions, such as which genetics to choose. You have to track metrics to know what your costs are in case you need to change management, like a master grower. Need to work with an accounting firm to help with that; there are no good IT solutions. Seed-to-sale software is set up like the regulators are the clients, not the growers. It doesn’t really do costing – you can enter it but you have to calculate it.

• There are ways to track, especially with modern facilities set up with SOPs, handbooks, operating procedures and policies. You can track labor time for specific project assignments and check the job for satisfactory work. A key point is that time is of the essence when you’re talking about your crop. Tracking all costs will get you a realistic price of pounds per production down to the price per gram.

• It is best to implement cost tracking from the beginning. Once it is set up, it can be built on and maintained. It’s a good business practice in general, especially in the cannabis business where you are going to be audited by the IRS.

Out of startup space and into a fully functional facility – challenges to costing in real-time

• Industry is aplenty with master growers, but turnover is frequent, so the biggest challenge is having something like SOPs in place in case your management changes.

• Capital requirements are high, cash flow is always tight, margins are slim, labor intensive—sometimes SOPs fall by the wayside in the effort to get product out.

• Many master growers from the traditional industry are skilled but without resumes.

• Should you build out or retrofit a building? That is one example of the challenges for people moving from the traditional industry to legal development. Another is getting the number of employees you need, and what that involves, such as benefits packages. There is typically a disconnect between people who know the work side of the business and understanding the costing issues related to ensuring a profit.

• Have to proactively track your costs to make key decisions, such as whether to use labor to accomplish a task or invest in technology that will reduce your need for labor.

• You might want to let the distributors do the packaging.

• You have to diversify. You don’t want to do the same strain forever. Have to find your niche and determine what the market wants.

• Have to get cost accounting down to an SKU level. Knowing your costs of genetics and your return on that investment: if you can track that and gauge profitability by strain, you can maximize the value of your facility. But it is difficult to get there.

• We see people struggle with labor studies and equipment usage.

• How many watts of light are you using? You would like to know that on a daily basis. Need to keep a daily journal of light required, heat intensity, and humidity. It comes down to how tightly you are parameterizing your operations.

• Historically we’ve seen year-end costing being done. But the decisions that need to be made to improve the process are missed when you do it in hindsight. Setting up systems can be time-consuming but if you don’t have that expertise, it’s worth bringing in a consultant to take developing tracking SOPs off your master cultivator’s plate. By identifying inefficiencies you can save much more time and money in the long run as opposed to looking back at the end of the year to recognize costing issues.

• Operators are embracing opportunities to button up their business practices. Things are changing extremely fast, including production technology. Tracking is how you stay current on up-to-date practices and don’t get left behind by someone who can produce better quality and higher yield.

• Tracking will be essential to change from traditional cultivation to getting into the legal industry and complying with those requirements.

Companies operating in the cannabis industry, especially cannabis cultivators, are no strangers to IRS Code Section 280E and its provision that businesses legally cultivating or distributing marijuana products can only deduct costs-of-goods-sold when calculating federally (and some state) taxable income. General and administrative expenses such as salaries, rent, and advertising aren’t deductible.

So, if costs-of-goods-sold is the only category of expense eligible to be deducted, how can businesses ensure they are maximizing their deductions? By accurately recording inventory from seed to sale.

All states that have authorized the production and sale of marijuana, whether for medical or adult use, require the use of seed-to-sale tracking software. The software is mandated by the states to ensure compliance with cannabis laws. While seed-to-sale software enables cannabis businesses to update inventory as it moves from stage to stage and maintains a log of all employees who have handled the inventory at each stage, the software has presented cultivators with challenges, including:

• Accurately recording harvested plants moved to the drying rooms
• Appropriately updating the weight of work-in-process inventory after it has been removed from the drying room and before it has been packaged as a finished good
• Appropriately tracking inventory physically still in work-in-process inventory but moved to “finished goods” in the seed-to sale software prior to packaging
• Producing historical reports

Such challenges can lead to the improper recording of inventory and non-compliance with relevant state regulations. The following procedures can be used to mitigate those risks:

• Save reports from the seed-to-sale system daily.
• Perform cycle counts of all inventories:
  • Once a week for all raw materials
  • Once a week for work in process inventory
  • Three times a week for finished goods
• Keep a physical inventory sheet in each room to be signed by employees as they make updates and a digital copy outside the seed-to-sale software with the same information.
• Reconcile reports from the internal spreadsheets with reports produced by the seed-to-sale system after each internal cycle count is performed.
• In the rooms containing work-in-process inventory, physically separate and label the inventory being regarded as finished goods in the seed-to-sale system.

It is important to remember that while seed-to-sale software helps track inventory, the software is still subject to human error.

The importance of properly recording cannabis inventory should not be underestimated. It is the key to understanding operations and consumer patterns, and correct financial reporting, as well as compliance with regulations.

For additional inquiries or cannabis consultations please contact HBK Cannabis Solutions at 856-486-2299.

Register for the next cannabis webinar on April 8, 2022 here.