The cannabis industry may be booming, but it’s fraught with complications. Margins are tight, licensing fees are high, competition is fierce, and compliance concerns abound.
Even though cannabis is legal for sale in most states, it is still considered an illegal substance by the federal government. It is therefore subject to restrictive taxation aimed at preventing drug traffickers from profiting from its sale.
Internal Revenue Code 280E restricts cannabis companies from deducting normal business expenses, save for those directly attributable to the cost of goods sold (COGS). Until the FDA down-schedules cannabis from Class I to Class III, all businesses engaged in the cultivation, sale, distribution, or manufacture of cannabis and cannabis products must adhere to this law.
So, while business is good, operators are skating a fine line. Any missteps can quickly put you in the red and potentially put you out of business altogether. The best defense is to set your business up properly from the start, maintain clean books, and work with a cannabis accounting professional who can guide and advise you on financial decisions.
For those of you preparing to launch a new cannabis enterprise, we’d like to share some fundamental bookkeeping strategies that will help you establish a solid foundation from the outset.
Cannabis Bookkeeping 101
Cannabis Industry Challenges
The cannabis industry has unique financial attributes that are not found elsewhere. Here are a few:
- Few banking options. Since cannabis is still a Class I substance (at least, for now), most of the big banks won’t take you on. Some are starting to soften, but the current reality puts operators at a disadvantage, with limited options, high account fees, and significant security risks due to a predominantly cash-heavy environment.
- Significant security risks. Between the product itself and the oodles of cash the average operator handles, security is an ongoing concern. Theft or fraud can put your business at risk and can also invite legal troubles.
- Taxation is complicated, but it must be tracked meticulously to ensure compliance. Under IRC 280E, you will not be able to deduct typical business expenses, like lease payments, utilities, payroll, security costs (although security is federally mandated), marketing, office equipment, software, computers, and so on – unless they can be attributed to COGS. As you might surmise, businesses involved exclusively in cultivation have it a little easier, as most of their overhead is connected to COGS.
At any rate, it is critical to categorize all expenses accurately, which may require expert guidance. You can’t write off security costs or utilities, but you can deduct a portion of those costs if they are connected to managing the product itself.
For example, dispensaries can deduct expenses related to inventory, including storage and security for their inventory. They would need to determine what portion of their security and real estate expenses is attributable to COGS, but this can’t be arbitrary. In addition to allocating the cost, they must also document the rationale behind the calculation. Audits are a fact of life in the cannabis industry, and auditors will want to see this.
- Some states are decoupled from 280E, but while this provides much-needed relief, it’s not carte blanche, and actually creates an additional layer of reporting complexity. To take advantage of all the benefits of decoupling, operators must maintain two sets of books detailing all allowable expenses.
- Local jurisdictions have their own cannabis taxation. Knowledge of local and regional cannabis compliance and taxation is essential to avoid penalties and unnecessary audits.
- Laws are changing constantly. From the federal level to the states, counties, and cities, cannabis rules and taxation are in a constant state of flux. Keeping up with the changes may seem like a full-time job–and it is–but ignore them at your peril. Noncompliance can result in costly fines and even license revocation.
- Licensing and renewals can be complicated and costly. Cannabis licensees must keep their licenses up to date to ensure business continuity. Initial license fees are expensive, often into the tens of thousands of dollars, and renewals may be just as dear. Renewals are not always quick, so operators must be prepared for submission well in advance, which includes understanding submission timelines and budgeting for renewal fees.
The good news is that good bookkeeping practices can help you mitigate many of these issues and help to preserve profitability. Implementing financial best practices, prioritizing generally accepted accounting principles (GAAP), and integrating accounting platforms with cannabis-specific software will help to lighten the load.
Cannabis Accounting Best Practices
Some of the most significant bookkeeping issues cannabis operators face are primarily due to the large amounts of cash they handle. It’s relatively easy to track point-of-sale data. Still, care must be taken to document all cash transactions, both incoming and outgoing.
- Implement a reliable accounting system. Ideally, you’ll want to choose cannabis-specific software that allows you to track multiple taxes, inventory, and expenses, and generate compliance reports.
- Ensure all business software integrates with critical systems to minimize errors and simplify reporting.
- Prioritize checks and balances for all transactions to ensure transparency and accountability. Daily cash counts help identify discrepancies between the cash on hand and what is recorded in the books. A two-person system is essential when counting money at the end of the day, ideally monitored by both physical and digital security, and confirmed with a smart safe.
- A third person should be responsible for reconciling cash transactions to reduce the chance of theft and ensure objective accountability.
- Reconcile the seed-to-sale software with physical inventory and POS data regularly. Seed-to-sale platforms are state-mandated for compliance. However, if the data is inaccurate, things can get sticky. Ensure POS data matches seed-to-sale data and physical inventory to avoid issues. Ideally, you’ll want to do this daily or weekly, as it will help you get ahead of any problems.
- Maintain detailed transaction records. Doing so will not only support a smooth audit process but will also provide essential insights into your cash flow and sales patterns, helping you make better purchasing, pricing, inventory, and budget decisions.
- Stay current with regulatory changes. While this undertaking may seem monumental, you don’t want to miss details, as noncompliance will almost certainly result in additional scrutiny.
The Bottom Line for Cannabis Bookkeeping
Working with a qualified cannabis bookkeeper or accountant is highly recommended, especially for new cannabis licensees. The highly nuanced cannabis industry and its regulatory landscape are not for the faint of heart, but the proper guidance will set you on the right track.
