How Expensive Is Expired Inventory in the Cannabis Industry?

How Expensive Is Expired Inventory in the Cannabis Industry?

No one thought it was possible when cannabis was first legalized, but there is a growing problem in the cannabis industry: expired inventory.

Cannabis is, ultimately, a green and leafy plant. It conforms to all the rules of plant life, including the fact that it can go bad. Once you remove a cannabis bud from the stalk, it dies just like any picked flower. It begins to dry out, wither, and eventually rot if not cured correctly. Even processed cannabis products go bad over time, just more slowly. Cured bud becomes too dry and crumbles into dust. Refined concentrates slowly break down chemically until the quality is degraded.

 

The Growth of Expired Cannabis

 

Unfortunately, some states have been a little too effective at creating an inventory before demand has a chance to catch up. Even Canopy Growth, the world’s largest cannabis company, is shutting down over half it’s greenhouses. Partly to grow outdoors, now that this is legal, but also because they are producing more buds than anyone knows what to do with. And the excess is expiring in storage.

This is a problem for dozens of cannabis grow-ops across the country. When demand doesn’t meet the cannabis plant’s incredible ability to produce, you wind up with expired extra. now let’s talk about what that expired cannabis inventory is really costing you, and why to trim your production to meet local demand.

 

Greenhouse Resources

 

  • Planter
  • Fertilizer
  • Water
  • Lights
  • Climate Control

 

The first cost of expired inventory needs to be assessed right at the beginning: the resources you use to grow. How much do you spend on lights, climate control, nutrients, soil, and of course the green house space itself? That all adds up. Together, your growth costs can be calculated as a lump sum. Now divide that sum by the total number of ounces of bud you harvested. That’s your cost per ounce of cannabis to grow.

Now multiply your growing cost-per-ounce by the number of ounces that were expired and had to be thrown out. That’s the amount in grow-costs (or the Grow-ROI loss) incurred by expired inventory.

 

Product Processing Costs

 

If you process your own bud, as many grow-ops do, then expired finished products that go unsold also cost you every step along the way. Just like your greenhouse growing costs for unsold cannabis, you’ll be losing a similar percentage of the investment you put into processing the cannabis products.

Whether you are curing bud to last longer in a jar or you’re refining concentrates into butters and shatters, the resources you use to produce expired products are part of that expiration cost.

 

Materials

 

Every cured batch of cannabis uses up a few key supplies. Chemicals used to cure the leaf or concentrate the dab must be restocked, even if you don’t sell what they were used to produce. Dishes and implements, disposable gloves and safety gear, and the supplies used to clean up afterward are all part of the cost.

 

Man Hours

 

Don’t forget the value of your employee work hours as well. From the growers who tended and harvested to your teams working carefully to cure and concentrate, no doubt a few hours went into every product that goes unsold. Pay those wages without direct ROI from revenue.

 

Wasted Packaging Materials

 

For brands that package their own products, as many do, packaging costs should also be considered. There are many precise regulations on how cannabis products must be packaged and labeled. Seal, child-proof, label as cannabis, and include finer details. This means engineered custom packaging every time.

Most brands package all of their created products, whether or not a sale is guaranteed. Of course you do, how else would your products get into customer hands? But each package put on cannabis that expires is technically wasted material. It must ultimately be thrown out rather than reaching customer hands.

 

Storage and Transportation

 

Another consideration is the cost of storage and transportation. When larger volumes of cannabis expire in storage, this can equal a significant cost in what you spent to keep the products. Commercial storage space, especially space that is zoned or will accept cannabis as the contents, is not always cheap or easy to find. Likewise with services or drivers who will comfortably transport your cannabis between facilities or out to local dispensaries.

One of the worst things about expired inventory is that it takes up the maximum amount of storage cost for its volume. After all, it sits in your storeroom or warehouse for the longest possible time before you throw it away.

 

Disposal Expenses

 

How Expensive Is Expired Inventory in the Cannabis Industry?

Men using a digital tablet in storage room.

 

Finally, there’s disposal to consider. Cannabis is classified as a controlled substance, even where recreational use is legal. This means that you can’t just chuck your expired product into the nearest dumpster and call it a day. Dispose of cannabis like a medication, which means contracting with a medical disposal service.

Each disposal is a pickup order and many services charge by weight as well as number of pickups. The more cannabis you must dispose of, the more medical disposal costs you incur.

 

Plan Ahead Carefully to Avoid Cannabis Inventory Waste

 

The cannabis industry is in a constant state of flux. Every state is changing differently as the laws evolve to support or challenge the system. You never know when the playing field is going to change again, the costs that change will incur, or even if that change is for better or worse. For example, part of the reason Canopy Growth is closing greenhouses is because outdoor cultivation has been legalized, and is more affordable in the long-term. Good in the long-term, but costly to adapt this year.

The good news is that savvy grow-op owners can plan for the future like any other retail supplier. Look at the numbers and watch not just where dispensaries are opening, but how many people are buying. Don’t expand too fast, and only increase your inventory size when there is a demand to meet your growing supply.

 

Sound Financial Advice for Cannabis Business Owners

 

Here at Northstar Financial Consulting, we know it can be challenging for Cannabis entrepreneurs, business owners, and industry leaders to get the kind of sound financial advice you need. Financial professionals and institutes often shy away from this brand-new and legally complex industry. That is exactly why we’re here to help.

Whether you need CFO services or someone to help you look over the trends and plan for next quarter’s inventory, we’re here to help.

How to Avoid 280E

How to Avoid 280E

The cannabis industry is a rapidly growing market. We have helped many cannabis businesses reach financial success and grow exponentially. Even though there are exciting success stories, the cannabis industry and cannabis business owners are still facing massive challenges specifically related to their niche market. 

Many challenges to the cannabis industry involve unique complicated accounting and tax laws. For instance, federal income taxes are based on a simple equation: start with gross income, subtract business expenses to calculate taxable income, and then pay taxes on this amount.

Unlike most traditional businesses, the cannabis industry is subject to Section 280E of the Internal Revenue Code. Section 280E is a federal statute that forbids businesses dealing with Schedule I or II controlled substances, such as cannabis, from deducting ordinary business expenses from their taxable income.

Simply put, unlike most businesses, cannabis businesses are likely paying a substantially higher effective tax rate just because they cannot take normal deductions associated with selling cannabis, such as employee wages, accounting, systems, rent, and more.

With that being said, our most common question from clients is: Okay, how can we avoid 280E? 

Well, you can’t. 

At least not entirely. There are a few things you can do to significantly reduce your tax costs while staying within the 280E regulations, if you just keep on top of your game. Many cannabis companies aren’t aware of these exceptions. Knowing what to do, what you’re looking for, and having a team of financial experts to point them out, can save you big bucks on your IRS tax return.

How to calculate “Cost of Goods Sold” (COGS) under 280E 

Section 280E does not prevent cannabis businesses from deducting the cost of goods sold. Identifying whether deductions can be allocated as COGS can make a significant impact to minimize the tax on your cannabis business.

If you are a cannabis cultivator, examples of COGS are raw materials and supplies, including seeds, clones, fertilizer; indirect product costs, such as equipment maintenance, utilities used to grow cannabis, wages of supervisors; and quality control and inspection costs. Labor-related COGS could be deducted for cleaning, trimming, curing, packaging or inventory. 

For businesses that are exclusively a dispensary, COGS are limited to the cost of the product and the costs of acquiring the merchandise. This can include transportation costs to purchase wholesale cannabis. Deductions may also be claimed for electric bills for designated inventory areas. Virtually everything else, such as employee salaries, marketing, advertising costs, rental fees for facilities and more, are subject to 280E limitations in a retail environment.

Having an accountant who specializes in cannabis businesses can help you go over all of your expenses and determine what items can be considered deductible. It is worthwhile to have someone with this experience so that they may guide you to maximize your potential deductions. 

Does your cannabis business perform another function?

The tax court lets businesses separate cannabis sales from other types of business transactions. If you have other parts of your business that isn’t directly related to cannabis and it generates real income, then this could be an option. This means the second business can deduct business expenses as usual for the non-cannabis business activities.  This will require “proof” that the non-cannabis part of the business could stand on its own, separate from the cannabis business itself. That means separating out payroll, operating costs, etc.that are specifically for the “second business”. 

The separateness and business expenses must be documented because there is a likelihood of an audit. Your financial professional should be able to assist you in separating out the expenses. 

Accurately track employee timesheets for COGS

Hours worked by employees doing tasks related to cannabis production are deducted under COGS. Therefore, employee time spent cultivating, packaging and doing inventory management is deductible under Code 280E.

Accurately tracking time could make a big difference in your COGS number, so you want to pay close attention to this. To help facilitate the process try using a time tracking system. The time tracking system should be customizable and allow employees to record time by individual activity.

Understand corporate structures

Choosing a structure for a company is an important decision. This decision must be well researched and strategically thought out because it could either help or harm your business. For a cannabis business, you generally are choosing between a C-Corporation, S-Corporation, or Limited Liability Corporation (LLC).

For larger scale cannabis business,  CPA’s and legal advisors usually recommended setting the business up as a C-Corporation. Under United States federal income tax law, a C-corporation refers to any corporation that is taxed separately from its owners. A C-corporation is different from an S-corporation because an S-corporation is generally is not taxed separately. 

Since a C-Corp is a tax-paying entity, the corporation pays taxes on the company’s gross profit. That means the business owner only pays taxes on salaries or dividends.

Keep your accounts updated and in order

The IRS requires you to keep receipts for all transactions as evidence on your tax return. This means all revenue and expense must be accounted for, no matter how small. Since 280E only permits the deduction of COGS, the IRS generally goes through these numbers with a fine-toothed comb. If there are mistakes or inaccuracies in your deductions, your business may be subject to a fine.

As a cannabis business owner, your company is more likely to be audited. Cannabis is considered a federally illegal substance and is subject to more scrutiny than other products.  This is why staying organized, well-versed on tax laws and tracking employee hours is so vital for the survival of your business. 

Local and state taxes vary depending on where your business is operating. You will be responsible to know and adhere to all of your local state laws or to find a reputable tax advisor to help you. 

Expert accountants in the cannabis industry are familiar with the laws better than anyone else. They understand all the details and tricks of Section 280E, what is considered a COGS and what isn’t and how to correctly, and legally, minimize your taxes. They can help ensure your tax return is filed promptly and accurately,  provide required supporting documentation, and help you avoid an audit. 

This might all sound very overwhelming, but it could save you a lot of cash. Contact us today for a free consultation, and find out how we can help you significantly improve your cash flow.

Call: +1.424.274.3188