Financial forecasting methods in cannabis are essential for success. The industry environment is continuously changing, and the right predictions can make it easier to navigate.
Every business should utilize a financial forecast. This is especially true for those operating in cannabis.
The cannabis sector is experiencing tremendous growth at the moment, with Investopedia reporting canna-companies raised $116.8 billion in capital during 2019. Now is the time to understand what will happen throughout the industry, especially when considering the legal market should be worth approximately $73.6 billion by 2027.
To acquire your share of this expanding market, data is essential. With this insight, you’ll create a financial plan or forecast and know which factors will come into play. In this article, we’ll discuss financial forecasting and ways to improve your efforts with data.
Why Use Financial Forecasting?
The right financial forecasting methods give your canna-business an advantage by encouraging decisions based on uniform and cohesive reports. This information makes it easier to establish a foundation of realistic goals to build your business’s success.
Your canna-company can experience the following specifics with financial forecasting:
Maintain More Control Over Cash Flow
As you analyze your financial forecast, you’ll better understand your business’s future cash demands. With your projected expenses known, you’ll also know how much cash you’ll need to keep on-hand to cover your business’s costs.
A simple calculation of the minimum net operating cash you should have on-hand depends on a few factors, such as your risk tolerance. Regardless, it’s best to have between two and six months of your overhead expenses on-hand at any given time.
With your forecasted financials, you’ll know your monthly expenses. Then, you can multiply this number by the number of months per your risk tolerance.
For instance, if your company costs $6,000 to operate and you feel comfortable when you have six months of operating expenses covered, you’ll want to have at least $36,000 on-hand.
With cash-on-hand, you’ll have money in case something goes awry. Regardless of which industry you operate, there’s always some unexpected expense to cover.
Effective financial forecasting produces cash flow control that will cover any fluctuations in your expenses. Whether a mistake was made or the industry changes, you’re covered.
Use an Operations Budget as a Key Performance Indicator (KPI)
Your annual operating budget for the year ensures you’re always on track. With this budget, you’ll manage your progress month to month and calculate how your business performs in comparison to your plan.
You’ll know which costs are high or low, along with which sales are higher or lower on average. This information will guide you in taking corrective measures whenever necessary.
An operations budget also acts as a key performance indicator that you can use to perfect your financial forecast model. For instance, if your business performed better last year than this year, it might be best to make adjustments next year. This is the sort of insight your operations budget will provide.
Keep Yourself Ready for Significant Price & Revenue Changes
Operating with insight ensures you’re prepared for the worst. Some months will be better than others, and accurate data will help you appropriately manage the cash you have on-hand. But this will ultimately come down to the financial forecasting methods you have in place.
Financial Forecasting Methods to Incorporate in Your Efforts
Your financial forecasting methods are how you’ll gather the data your company needs to operate successfully. Instead of doing things based on ideas or what you think will work, you’ll have hard evidence to project your canna-business forward.
Analyze Comparable Businesses
Determining how accurate your financial forecast is can involve comparing your projections with other similar businesses.
Since the majority of canna-companies keep to themselves, you won’t always find their projects readily available. This is where you can get creative.
A cannabis CPA will have access to this information, so when it comes time to gather this insight, you can always ask for help. If this is something you need assistance with, we can help by comparing your forecast to our other clients operating in cannabis.
Map Multiple Scenarios
As you forecast your business’s performance, you might consider sandbagging. This is when you predict a low value you believe is easy to achieve because it feels safer to set lower expectations.
Another common strategy is to be optimistic, establishing high expectations for your canna-company. While these two methods differ, you can use both to analyze your business’s potential.
You should map out at least two scenarios. We suggest mapping at least one that’s optimistic and another that’s more conservative.
Mapping multiple scenarios is especially important in the cannabis industry. This sector is characterized by uncertainty due to the various government regulations. But other qualities can influence the unpredictability of this industry, including economic growth and new competition or licenses.
All in all, it’s best to track your business throughout the year. This will give you an average for your financial performance, making it easier to calculate more accurate predictions for the year.
Predict Expenses First
Your expenses will usually be easier to predict than your revenues because they involve fixed numbers. These include rent, licensing, insurance, and other expenses you expect to pay each period.
You’ll then have to anticipate your variable expenses. Include your utilities and other costs that fluctuate in this calculation.
To ensure your prediction is as accurate as possible, it’s best to analyze all details of your product costs. For example, retailers should know their inventory costs, as well as what they pay in salaries and wages. As a retailer, you’ll need to know your cost per pound of flower, per gram of oil, and for any other products you carry.
These variable numbers will guide you as you find your topline revenue numbers for your forecast.
While your expenses and revenue will vary, you’ll add any additional factors as you calculate. You’ll begin with your known fixed costs, and then you’ll analyze other aspects of your operations to predict everything else.
For example, if you’re a grower, you know your rent because it’s fixed. You also know how large your grow space is, and you can calculate how many grams per square foot you’re likely to produce. In turn, you can estimate the revenue you’ll generate each growing season.
These numbers provide you with insight-driven data, leading to a more accurate forecast. And this is where you can change certain variables to ensure a positive ROI.
Reanalyze Your Model Regularly
Your business’s progress should never remain static, and neither should its financial models.
Analyzing and reanalyzing your model will reveal your growth rates. But you’ll also get a good idea of your true product cost inputs, how your marketing campaigns affect your business and offer insight into how your business performs.
You’ll also take the guesswork out of your business’s updates. Look over expense percentages, revenue, input assumptions, and other internal and external factors to determine more accurate numbers. These numbers tend to change throughout the year.
Your business’s past performance can be used as a signal for change. Alter your model under newer and more accurate data.
Factors to Consider During Financial Forecasting
While you can’t predict everything that will affect your business, you can perform an analysis for financial forecasting purposes. Understanding some of the factors that come into play will contribute to your success in creating your cannabis business’s operating budget.
Keep in mind, this is not a list of all factors that could impact your business’s financial forecasting. But these are essential to consider as you build out your financial projections.
Tourists
If your operation is located in or en route to a seasonal tourist destination, you’ll likely notice a peak in revenue during the year. This, of course, all depends on when tourists are drawn to the area.
If your seasonal tourist destination is a lake or beach, the warmer months will likely produce an uptick. But if you’re more of a winter destination, like the X Games in Denver, you’ll notice it during the colder months.
Understanding when these upticks occur will encourage you to save during these busier months. This ensures you’ll have enough cash-on-hand to get through your slower months.
Seasons
Seasons will impact your business’s finances too. If you’re in retail, your raw material costs could go up or down. Knowing your input costs will help you maintain your margins as these costs increase.
Cultivators, in particular, know all too well how seasonality affects business. October harvests from outdoor crops usually result in lower prices, especially for those operating in outdoor flower. Oil and other cannabis product prices might also decrease.
Changes in supply are seasonal and should be tracked. There’s also opportunity associated with some seasonal changes, like holiday offerings and sales that could increase revenue when appropriately navigated.
Daily Fluctuations
Even though daily fluctuations usually belong in a more granular forecast, it’s still ideal to consider how your sales fluctuate daily. This is especially the case when considering how your business’s location can affect the amount of traffic it receives each day.
For instance, if your business is in your city’s downtown area you’ll likely notice more traffic Friday and Saturday. But if you’re operating in or near a central business district, your traffic will be more significant on weekdays rather than weekends.
Your Marketing
Each market campaign is on a mission: to drive more revenue. But there’s no telling how your campaign will go, especially if this is your first campaign.
While long-term campaigns can be easier to predict, you’ll need to track your sales to fully understand how the campaign will affect your sales.
For instance, let’s say you distribute coupons to some neighboring communities. These coupons are delivered on Wednesday, and then, you’ll analyze how your sales are impacted each day following their release until your coupon expires.
As time passes, you’ll notice a curve. This curve will help you determine how much inventory you’ll need in the future as you incorporate a similar campaign into your marketing efforts.
Suppose you plan to operate multiple similar campaigns this year. In that case, you would use the insight you gained from that initial campaign to forecast campaign expenses and the resulting increases in sales.
Weather & Climate Fluctuations
Consider the typical weather where you’re located. For instance, when it rains, you might notice a decrease in sales. Depending on where and what you operate, the weather could impact your sales, and it’s important to know what to expect.
As far as climate is concerned, winter and summer temperatures can cause fluctuations in sales too.
For example, as a retailer, you might sell more flower during the warmer months when people are more likely to go outside to smoke. On the other hand, you could see an uptick in vape cartridge sales during the winter when people are more likely to consume indoors.
Natural Disasters & Pandemics
There’s no predicting when a natural disaster or pandemic will occur. But it’s crucial to know how these uncontrollable events could impact your operations.
For instance, the COVID-19 pandemic has brought on an increase in cannabis sales as the average ticket price rose. Once it was deemed an essential industry, the cannabis sector in California has observed some of its best months since legalization.
But during Cali’s wild-fire season, its outdoor grows could be impacted. The fires can burn away supply, cut off the power supply for indoor grows, and result in other damage. For times like these, it’s important to have a fall-back fund to handle these emergencies.
As you can see, a state of emergency can increase or decrease revenue, and it’s critical to consider whether your business will be impacted during a time of crisis.
Tax Increases
Tax increases are especially relevant in the cannabis sector.
Consumer taxes on cannabis have been known to rise, and if the state’s black market operates in full force, there’s a chance that some consumers will begin shopping at unlicensed retailers. This is especially common in California.
However, some states don’t have such an active black market. For example, Michigan doesn’t have many illegal pot shops in operation.
Another option for consumers is to purchase directly from the source. If the taxes increase, local growers will offer direct access to their product. But it really varies from consumer to consumer as most might not feel comfortable purchasing from a local grower.
For cannabis operations, increases in taxes could mean your minimum cash-on-hand requirements could rise. Your tax money should be kept separate from your working capital.
Tax money should be taken from revenue and kept in a separate safe or account. This ensures you’ll always have enough money to cover your taxes come tax season.
Cannabis Sector Growth Rate
Natural growth and shrinkage happen in every industry. But in cannabis, we see it grow in popularity month after month and year after year.
Your financial forecast will probably include natural growth. But the main thing to track is whether you’re maintaining, expanding, or losing your market share.
Since there isn’t much public data available, it could be challenging to get an accurate forecast of how your market share is evolving. Thus, you’ll likely have to make estimates to determine how your market share is changing.
As you maintain a good understanding of your financials, you’ll become more strategic with your decision-making. If you’d like assistance with financial forecasting in the cannabis sector, please feel free to contact us at any time.
