Let's talk weed & money.
Let's talk weed & money.
A dive into cannabis accounting and finance.
The Broccoli Report
October 2, 2020
Time to read: 9 minutes, 25 seconds. 1884 words.
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Let’s Talk Weed & Money: A Dive Into Cannabis Accounting and Finance
Anyone who has ever fired up Quickbooks knows that “user-friendly” is a relative term when it comes to accounting software. And even if you make it through the tangled, confusing web of video walkthroughs and forum posts, DIY accounting is tricky and time-consuming. Add in weed, and things get even more complicated.
So, what’s a small weed business to do? Today, Erin Rulli from Alice & Fran LLC talks about business accounting, with a particular focus on balancing the books for creative cannabis businesses. Full disclosure: While this is not a sponsored post in any way, Broccoli is one of Alice & Fran’s clients.
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LY: Accounting can be expensive, especially for small businesses. What’s the case for hiring a professional?
ER: The greatest benefit is the time and energy small business owners get back when they hire an experienced accounting and finance professional. Quickbooks (QBO) and other accounting software options are user-friendly, but what people don't realize is that you have to understand the basics of accounting and bookkeeping and financial reporting to use the program effectively. I've spoken with a number of business owners who are convinced that their books are good-to-great only to discover they're incomplete, inaccurate, or they're not taking advantage of the time-saving and organizational tools available in the program.
There are a lot of other benefits, too: Maximizing your business tax deductions (sorry, no haircuts!); having accurate information to perform trend and comparative analyses; not worrying about late fees and penalties on sales tax or cannabis tax; recurring financial reports that help you understand the financial health of your business and more importantly, identify opportunities for revenue growth, expenses management, and smart purchasing; and having a liaison with banks, lenders, attorneys and regulatory agencies who understands the acronyms, processes, and systems to meet deadlines and make transactions as painless as possible.
LY: We see people scrambling to find someone around tax season, but having someone prepare your taxes isn’t the same as having year-round assistance. Talk to us about the best time to upgrade to working with a professional.
ER: Year-round assistance is a concept that I wish more business owners would embrace. The ideal situation is to hire an accountant to set up your books and do some basic training with you prior to officially launching your business.
Once you’re up and running, there are three clues that might signal that it’s time to hire a professional. The first is when you're feeling stressed about the time and effort it's taking to keep up with the books, and it's taking away time from your actual work. The second is if you have doubts about the accuracy of the information—you don’t want to get in too deep if there’s an error at the start. And the third clue is that your transactions are becoming more complicated—for example, you have multiple bank accounts, loans, payroll, diverse revenue streams, etc.
LY: Okay, so once you’ve decided that you’re ready for an accountant, what’s next?
ER: Business owners should ask themselves: what's my budget? A reasonable amount to spend is between 1% to 2% of annual revenue per month. Most bookkeepers and accountants have a minimum fee for monthly or quarterly services. Many are willing to work with small business owners on an affordable solution, especially if you have an exceptional business plan with realistic revenue projections and a willingness to do the day-to-day accounting entries internally.
They should also ask: What type of services do I need or want? If you’re a company with a simple business model, getting set-up and trained in QBO might be all you need. Suppose you’re an established business with rapid revenue growth and a more complex business model. In that case, the best option is usually monthly services that incorporate a bookkeeping review, monthly financials, and an annual budget. Larger firms typically offer full-service solutions (bookkeeping through annual tax return) with different team members handling tasks based on their specialty and communication managed centrally via a client portal. The advantages of working with these firms are expertise, one-stop-shopping, and a traditional business "feel." Small firms’ services range from quarterly bookkeeping and annual tax returns to monthly financial reporting and part-time chief financial officer (CFO) services. Custom packages, personalized service, and in-depth industry knowledge are just a few of the advantages of working with a small firm.
And finally, they should ask: Who should I hire? Your goal should be finding a professional firm that offers the services you want, that you feel comfortable communicating with, and is excited to work together with your company. This business will effectively be your accounting and finance department, so it's important to choose someone you can trust and develop a healthy business relationship with them. Your search for a provider should start with your network, then move to established industry association directories, LinkedIn, Instagram, etc. We recommend talking to two to four different companies of various sizes to fully understand your options and whether you want to work with a traditional or a specialty boutique firm.
Alice & Fran LLC’s initial consultations are complimentary, and calls range from 30 to 60 minutes. I start the conversation with a series of questions (history of the business, revenue size, number of employees, type of entity, current accounting software, financial goals) that allow me to gather the information I need to provide a proposal for services. I open the call to questions, and if it seems like it might be a good fit, I'll attempt to engage the caller(s) in an informal conversation. We only work with nice people who are committed to having excellent books and records—and who have a sense of humor.
LY: Does a licensed cannabis business need an accountant who specializes in weed? What about hemp-based CBD brands, or ancillary companies like pipe-makers?
ER: Plant-touching businesses need an accountant with cannabis-specific training. It's most important for cultivators and manufacturers as they have the opportunity to allocate more expenses into Cost of Goods Sold (COGS; the only deduction allowed for cannabis businesses) via cost accounting. Still, there are regulatory and tax considerations in all verticals, including retail and delivery. The cost accounting to maximize COGS is not a common practice for most accountants, so you'll either pay too much in taxes (oh no! cash flow!) or too little (the IRS loves their fines, fees, and penalties).
For hemp-based CBD brands and ancillary companies, it is not absolutely necessary to work with a cannabis accountant. However, my personal opinion is those businesses are still best served by cannabis accountants. We know the banks and payment processors who will work with cannabis businesses, what law firms to recommend, the best software options, etc. And when it comes to taxes, specialization matters. There are so many considerations for cannabis businesses: sales tax, cannabis tax, excise tax, cultivation tax, income tax, payroll tax, etc.
LY: Have you had cannabis/cannabis-adjacent clients get their assets frozen by banks/online processors before? Have you faced similar challenges for your business?
ER: Oy! Yes! I have had clients whose assets have been frozen, and it can take up to 180 days to recover those funds—and that's if all parties cooperate and things go smoothly. I have a former client who has been waiting over a year for funds to be released. It's a frustrating and time-consuming experience. More recently, I'm seeing that banks and payment processors continue to close plant-touching and ancillary accounts but are not holding the funds, releasing them immediately to the account owner. It's not a lot of progress, but it's some. I don't think you can ever become accustomed to the panic and chaos that ensues when an already financially-strapped business loses yet another account; another "normal" aspect of doing business.
My business bank account was closed the Friday before Memorial Day weekend. I had moved earlier in the year, and I missed a letter from my bank. I discovered they were unwilling to work with me when I got a surprise email saying my account balance was zero. I had been contacted via phone about six weeks prior regarding a "regular audit of business accounts" and asked whether I was doing business with cannabis companies. I answered honestly and asked if my account would be closed. The reply read, "It shouldn't be a problem." Guess it was!
LY: I saw the IRS recently issued guidance on a small loophole for businesses to reduce gross receipts via Section 471. Help us understand how the update impacts cannabis companies.
ER: Cannabis businesses cannot deduct standard business expenses under IRC 280E, but they are allowed to reduce gross sales by the Cost of Goods Sold. What can and cannot be included in COGS varies by business type (cultivation, manufacturing, retail) and revenue size.
The use of Section 471C, included in the 2018 Tax Cuts and Jobs Act, states that companies reporting less than $25M in revenues are allowed to count all expenses—including things like rent and utilities—as directly related to the cost of inventory (a.k.a., cost of goods sold). This would be a huge win for the industry, particularly distributors and retailers, but whether 471C overrides section 280E has not been decided by the tax courts as of yet. As of now, firms encouraging clients to pursue this strategy feel that if the IRS decides to challenge certain deductions, 471C can be used as a defense. There's a significant amount of risk for a small cannabis business using 471C to calculate COGS. Why? There is no guarantee that the IRS won't later deny the deductions after a very costly court battle, not to mention the taxes, fees, and penalties associated with the additional taxes to be paid.
Bottom line: It's a complex, high-risk approach that should be used with caution, and only if all the parties involved (owner, CPA, accountant, attorney) understand the level of risk and the technical aspects of the accounting. We're watching and waiting and hoping that cannabis becomes federally legal sooner rather than later, thereby eliminating this whole huge mess.
LY: What’s the accounting recommendation you can make that applies to everyone—from, say, a freelance writer who rents to a pipe manufacturer or a dispensary owner—the one thing to implement into healthy personal accounting practices?
ER: No commingling. Don't mix business and personal expenses, no matter how small your business is. Have one bank account for your business and another for your personal finances. No ifs, ands, or buts about it!
This interview was edited for length and clarity.
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See you Monday,
Lauren Yoshiko