Tips for Managing Cash Flows of Your Cannabis Company

Tips for Managing Cash Flows of Your Cannabis Company

Cannabis businesses face cash flow issues for a few reasons. The first big reason is taxes. Being subject to the tax laws under Internal Revenue Code 280E means there are less eligible expenses to deduct. This means income taxes are one of the biggest costs for cannabis companies. 

Secondly, the cannabis industry faces strict regulations which make it hard to get financing from a bank. Also, the life cycle of cannabis, from seed to sale, can take six months or longer. So, how do you sustain such challenges and keep the cash rolling in? Here are some tips on how to better manage your cash flow.

Inventory Management is Key 

Knowing the cycles of your inventory, such as the time it takes from seed to sale, is crucial. Every type of operator, from a cultivator to a distributor to a retailer has a different inventory cycle. And that equates to a varying cycle of cash inflow and outflow. A good inventory management system can track this information for you. It can also help you forecast product demand. Forecasting helps reduce shortages and overstock while maintaining enough supply of the products your customers love. Also, forecasting the demand for your products helps you better schedule your staff and manage your cash on hand.

Have a Plan when Business Complications Arise

According to the Small Business Association (SBA), 30 percent of new businesses fail in the first two years, and 50 percent fail within the first five. These statistics aren’t meant to frighten or discourage you. Rather, they highlight the realities businesses face when starting out and building a name for themselves. When a cannabis business fails, the likely cause is insufficient cash flow. Some of the primary factors for lack of cash flow is delivery rejections and net payment terms.

Retail Deliveries get Rejected 

Retail deliveries are one of the most regulated aspects of a cannabis business supply chain. When your deliveries don’t get accepted, it can hinder cash flow. Not only is this frustrating, but it can negatively impact a company’s financial standing.

The main reasons for rejected deliveries include; compliance errors with labeling and packaging and having inaccurate documentation. To make matters more complex, there are state and municipal regulations that need to be met.

To avoid complexities in your own business, make sure you stay compliant with current regulations. This can relate to the words used on product labels, product packaging and compliance of delivery vehicles. As a recommendation, start off making a small batch to sell to your retailer, then see if those get accepted. If not, at least the adjustments are only needed on a handful of products, compared to hundreds or thousands.

Net Payment Terms 

Many retailers place cannabis businesses on net payment terms. Meaning the invoice gets paid on a future date, rather than at the time of delivery. And it can take 30 or more days to receive payment. So, like rejected deliveries, payment terms can hinder working capital. This is all the more reason to reduce your risk of delivery rejections, adhere to labeling regulations, and track your accounts receivable balance.

Make Accounting and Financial Analysis a Priority  

Failure to keep timely accounting records can lead to cash flow problems. Not having an up-to-date regular financial snapshot of cash movement can catch a business off guard, such as when it’s time to pay bills and you discover there isn’t enough cash to cover the expenses. 

Although tedious and time-consuming, staying current with your forecasting, budgeting, and cash flow analysis is crucial for managing cash and it can aid in the financial success of your company. Not only that, but your vendors, employees, and taxes get paid on time. 

If keeping up with this kind of accounting and financial analysis sounds too complex, there are specialists, like Northstar, who can assist you. Accountants are valuable throughout the year, not just at tax season. 

Besides providing tax and accounting advice, seasoned cannabis professionals offer solutions to many other financial problems that may arise. They also provide answers to the most difficult business and regulatory questions.

Have a Financial Investor as a Backup 

The initial cash outlay to start a cannabis business is undoubtedly high. Even more, daily operation costs aren’t exactly cheap. And since many banks won’t finance a loan for a cannabis business, it can leave a new business feeling empty-handed. Yet, there are alternative forms of financial backing out there. A few examples include cannabis crowdfunding and seeking out personal investors. 

But, investors alone can’t keep you out of the red. It takes meticulous planning and bookkeeping to maintain adequate cash flow records. Accurate record-keeping helps you pay your taxes on time while ensuring tax compliance and so much more. To receive forecasting or other financial advice from expert cannabis accountants, contact Northstar at (424) 274-3188 or info@nstarfinance.com.

Cost Segregation: A Tax Savings Strategy for Cannabis Businesses

Cost Segregation: A Tax Savings Strategy for Cannabis Businesses

Cost segregation is a proven tax planning strategy that the cannabis industry can use to cut down on their income tax liability. For decades, the IRS has challenged this strategy in tax courts, but it’s been upheld time and time again. Although cost segregation is permitted under IRC 280E, very few business owners know about it.

What is the Formal Definition of Cost Segregation?

 

As defined under the Internal Revenue Code 280E, cost segregation is, “the process of identifying personal property assets that are grouped with real property assets and then reallocating those personal property assets for federal tax reporting purposes.”

Simply stated, cost segregation is a method your cannabis company can apply to claim more deductions on your tax return.

 

How Does Cost Segregation Benefit Cannabis Companies?

 

To benefit from this tax savings tool, you need to identify your personal property assets that are currently classified as real estate property. They’ll then need to be re-allocated to personal tangible property.

Re-allocating your assets gives you the benefit of depreciating them faster because depreciation time for personal tangible assets could be five, seven or 15 years. And this is significantly faster than the depreciation time for real estate assets, which can be 20 to 39.5 years.

This tax planning strategy means you can maximize your depreciation deductions much sooner.

What Types of Costs Qualify for Cost Segregation?

 

Operating expenses that may qualify for cost segregation include:

  • Task-specific lighting costs, such as your grow lights
  • Costs paid to operate your electrical, plumbing and security systems
  • Specialty systems used for achieving climate control
  • Expenses incurred to run your hydroponic and irrigation systems

Many of the costs spent on the build-out and operation of your cannabis business qualify for savings under this tax strategy.

 

What Kind of Buildings Qualify?

 

If your commercial, rental, or lease-hold building meets the following criteria, it can qualify for cost segregation:

  • Your building is currently being used in the operation of your business
  • Your building was acquired
  • You built internal structures that serve as grow rooms or inventory rooms
  • You made updates and improvements to the building

The two most important points are: your building is in service and you’ve taken ownership of the building (as the purchaser, leaseholder, etc.)

 

What is the Largest Potential Tax Savings?

 

Cannabis companies who use cost segregation to reduce their taxes can write-off anywhere from 18 to 30 percent of their facility expenses. This can translate to hundreds of thousands of dollars saved during the early years of operation.

 

How Much can my Cannabis Company Save?

 

To get an estimate of your company’s potential tax savings, it’s advised to consult a team of accounting professionals and cannabis tax experts, like the ones from Northstar Financial Consulting Group. A qualified, outsourced CFO understands what is needed to execute a proper cost segregation study. And they know which supporting documents and evidence are required for the IRS.

Examples of items needed to conduct a compliant cost segregation study include:

  • The address of your building
  • The in-service date of your building
  • The purchase price, less land
  • Cost of improvements made (if any)
  • Service date of your improvements, which appear on your Fixed Asset Schedule (FAS)
  • Square footage of asset(s)
  • Federal marginal tax rate and more

Fortunately, a cost segregation study doesn’t require an accountant to prepare an amended tax return. When your accountant completes the study, they submit a form and the necessary documentation to the IRS. This form captures an accurate depreciation figure, so you can receive the benefit of this tax savings tool.

Cannabis companies go years without ever benefiting from these deductions. Plus, many accountants and tax preparers aren’t aware of cost segregation as a tax tool.

Cost segregation is a strategy that can save your company thousands of dollars while maintaining 280E compliance. So, take advantage of this money-saving strategy by contacting Northstar at (424) 274-3188 or info@nstarfinance.com.

How to Minimize 280E Taxes for Your Cannabis Business

How to Minimize 280E Taxes for Your Cannabis Business

Knowing what expenses your cannabis company can claim on your tax return can be overwhelming due to IRS Code 280E. Internal Revenue Code 280E states that businesses who engage in the sale of Schedule I or II controlled substances, like cannabis, cannot deduct business expenses from their taxable income. Meaning, unlike ordinary businesses, a cannabis business cannot deduct the following expenses:

  • Employee payroll and benefits
  • Rental and utility expenses
  • Advertising and marketing expenses
  • Repairs and maintenance expenses
  • Office administrative expenses

However, there is an exception that will help your business subject to the Code 280E provision. This exception allows for the deduction of costs of goods sold (COGS). For a cannabis business, the COGS involve costs associated with the production of products. That means costs for seeds, soil, and nutrients are deductible. Likewise, expenses related to cultivating and harvesting cannabis fall under COGS as well.

This is an important distinction to take note of. Many cannabis companies aren’t aware of these exceptions. Having a team of financial experts to point them out can save you big bucks on your IRS tax return.

Because of this provision, a cannabis business ends up paying taxes on their gross profit, which could create a significant tax burden. In fact, they often pay two to three times more taxes than an ordinary business. But, with expert accounting advice and proper compliance, you can minimize the effect of 280E on your taxes. 

The following examples can help reduce your federal tax burden:

 

 

1. Separate Your Cannabis Business Activities

 

A business that is subject to 280E, can divide its business into two parts to help reduce taxes. The first business can be responsible for producing and distributing cannabis. This business would file a tax return with COGS as the only deduction.

The second business would perform business activities not subject to 280E. This way, you can take business deductions on your tax return, like payroll, rent, and marketing expenses. When combined, these two companies pay fewer taxes than a company operating as a single entity. This 280E strategy may sound complicated. But, partnering with a company like Northstar, can give you more insight into the nuanced rules and guidelines of Code 280E. And thus, it can help you save more money in the long run.

This 280E tax strategy is legal under the 2007 Californians Helping to Alleviate Medical Problems (CHAMP) federal court case. But, before you establish a second company, you must be able to state the business’ real purpose and revenue. Again, this is another time when consulting an expert is helpful. Otherwise, you might face the risks of tax penalties and violations (as was seen with Harborside).

 

2. Use Smart Corporate Structuring

 

Before determining the corporate structure for your cannabis business, consider the benefits and drawbacks of each entity option. Your three options include a C-Corporation, S-Corporation, and Limited Liability Corporation (LLC).

For a large scale cannabis business, legal advisers and CPA’s generally recommended setting the business up as a C-Corporation. Since a C-Corp is a tax-paying entity, the corporation itself pays taxes on the company’s gross profit and the business owner only pays taxes on salaries or dividends.

 

3. Track Employee Time by the Individual Activity

 

Certain hours worked by employees are deducted under COGS if those tasks relate to cannabis production. This means that accurately tracking time could make a big difference in your COGS number. To make this process easier, consider installing a time tracking system. It should allow the employee to record time by individual activity.

For instance, if an employee works as a budtender, their hours should be recorded under that activity. Employees involved in inventory, packaging, or cultivation would record their time as such. Accounted for correctly, time spent cultivating, packaging and in inventory management is deductible in COGS under Code 280E.

 

4. Be Prepared for a Possible Audit

 

As a cannabis business owner, your company is more likely to be audited because you’re selling a federally illegal (Schedule 1) substance. Hence, audit preparation is key. This is why staying organized, well-versed on tax laws and tracking employee hours is so important.

Also, did you know, Section 280E of the IRC requires your business to document all gross receipts and expenses? This includes revenue numbers for products sold in-store and online. It also includes cultivation expenses, marketing, seeding, inventory management, etc.

The IRS expects you to keep receipts for all transactions, to show as evidence on your tax return. Every bit of revenue and expense, no matter how small must be accounted for. Since 280E only permits the deduction of COGS, this number is often the most scrutinized by the IRS. If the deduction is incorrect, your business may be subject to a fine.

 

5. Work with an Experienced Cannabis Accountant

 

Section 280E applies to federal tax treatment for legal cannabis businesses, but that still leaves state taxes in question. State and local taxes vary depending on the state you operate in. This means it’s up to you or a reputable tax advisor to understand and adhere to state laws. This is just one more reason to work with an experienced cannabis accountant.

Expert accountants in the cannabis industry know the laws better than anyone else. They understand the ins and outs of Section 280E and how to correctly minimize your taxes. They can help ensure your tax return is filed accurately and has the proper supporting documentation. This kind of specialized service mitigates the likelihood of being audited and can ensure better cash-flow. Expert accountants can also offer expert advice on what’s allowable under COGS and what’s not.

For example, they know that businesses may deduct electrical bills for designated inventory spaces, but not for electricity used in sales spaces. And in some cases, the shipping costs related to the cannabis product can be deducted as well. Only experts have this information at hand.

Companies like Northstar Financial Consulting Group offer this expertise. They can provide your cannabis business with a full-service Accounting and CFO solution while helping to lower your 280E taxes. And they work diligently to ensure your tax return is correct.

 

Contact Northstar today at 424.274.3188 or info@nstarfinance.com to find out how we can help.