High Profits, Low Cash? Welcome to the Cannabis Biz Paradox

Cannabis accounting is complicated! But if you’re perplexed about the lack of cash on hand—despite running a profitable business—it’s a conundrum you need to solve.

Today, we’ll dive into the differences between cash flow and profits, deconstruct the paradox, and provide actionable tips to help you manage both like a pro.

Let’s start with the question that crosses every cannabis business owner’s mind at one point or another: if my business is doing so well, why is my cash on hand so scarce?

Truth be told, running a cannabis operation is a complex matter. From the stringent and ever-changing regulatory landscape to restrictions on who you can bank with, you need to be on your toes 100% of the time. While there is plenty of potential, it’s a never-ending balancing act to ensure your business remains profitable.

So, let’s break it down.

Cash Flow vs. Profit: Making the Distinction

The cannabis industry is unique in many ways. Most operations conduct a significant amount of business in cash, and all are financially constrained by Section 280E taxation.

Because so much cash flows in and out of the business, it may send false signals that your profits are greater than they really are. Understanding the distinction between cash flow and profits can help you frame your finances in a more realistic light.

What are profits?

Profit is the income that’s left over after all expenses, operating costs, and taxes are accounted for. There are three types of profit:

1.       Gross profit is your total revenue minus your cost of goods sold (COGS). COGS includes expenses such as packaging, cultivation, and distribution, among others.

2.       Operating profit is the gross profits less your operational expenses, i.e., payroll, utilities, lease payments, etc.

3.       Net profit is what’s left after all expenses are paid, including taxes, interest, and operational expenses not deductible under 280E. For cannabis operations, net profits are typically much lower because of 280E.

What is cash flow? 

Cash flow is, basically, money in and money out of your business and what’s on hand to pay day-to-day expenses. Cash flow is critical for any business; however, in the cannabis industry, where the majority of transactions are cash-based, maintaining good cash flow and having sufficient cash on hand is crucial.

In defining the differences between profit and cash flow, we can say that profit is what your business makes on paper, and cash flow is how much you actually have to run your business from day to day.

Why The Disconnect Between Profit and Cash Flow?

Your cash flow and profits don’t line up for several reasons. And while there’s no need to panic, it will require some diligence on your part to ensure you’re managing your cash flow well.

Here’s why there’s such a big disconnect:

·       280E. Need we say more? Until cannabis is rescheduled, companies can’t deduct typical business expenses, which leads to higher taxable income and higher taxes. So, while your income statement may show a profit, if you’re not accounting for 280E, you’ll quickly land in the red as you deplete your cash on hand.

·       Most of your transactions are in cash. Limited access to banking and other financial resources forces many cannabis businesses to prioritize cash transactions. This is not inherently bad, but it can be challenging if income and outflow are not meticulously tracked. Let this fall through the cracks at your peril, as it will almost certainly result in accounting discrepancies between profits and cash on hand.

·       Poor A/R processes can also tie up funds and impact both profits and cash flow. Payment delays can leave you with massive gaps, especially if you’re recording revenue before the cash is in your account.

·       Inventory management can also impact your profitability and affect your cash flow. You need to keep a certain amount of stock on hand, but overstocking reduces your available cash and won’t turn a profit until the product is sold.

·       High operational costs, start-up costs, and compliance costs can directly impact cash flow. Even if your profits look good on paper, these expenses can be substantial and will impact cash flow in the short term.

Getting a Handle on Cannabis Cash Flow and Profit

Financial success in the cannabis industry requires strategic thinking—and perhaps a creative reinvention of your accounting processes.

Here are a few tips to help you bridge the gap between cash flow and profits.

1.       Stay on top of 280E tax implications. Working with a cannabis CPA who understands the implications of 280E taxation can help minimize the impact on your profitability. Be proactive, forecast needs, and factor these into your cash flow projections.

2.       Optimize your inventory strategy. Using data to forecast seasonal demand and identify high-volume or highly profitable products to focus on. Avoid overstocking slow-moving items and align inventory levels with data-informed sales projections.

3.       Revamp your accounts receivable (A/R) process to expedite incoming payments. Enforce COD when possible, establish a standard workflow for tracking outstanding invoices, and consider offering incentives for early payment.

4.       Negotiate better terms with your suppliers. If you have a good track record of paying on time, consider negotiating extended terms with your suppliers to manage cash outflow.

5.       Track your cash flow meticulously. Establish a bullet-proof system for tracking cash flow. Specialized cannabis accounting software enables you to track transactions in real time, providing a more accurate snapshot of your cash on hand.

6.       Build a reserve fund. Emergencies happen. A reserve fund can help you weather disruption, pay for unexpected expenses, or get you through slow periods without impacting operations. Allocate a small portion of profits to the fund to grow it over time.

7.       Consider leasing vs. purchasing equipment. Business leasing is an affordable alternative to purchasing business equipment outright and can help you avoid large capital outlays and greatly reduce the impact on your cash flow.

The Bottom Line

Profits can be scarce for cannabis operators, especially if your understanding of cash flow doesn’t account for taxes, regulatory costs, inventory management, and other variables that can tie up your money.

While your business might look great on paper, your cash flow is a significant mitigating factor that can make or break your success. Be proactive, plan wisely, and be mindful of both of these key metrics, and you’ll thrive. As always, the cannabis accounting experts at Growise are always here to help. Drop us a line, and let’s get to work!