The secret to running a successful and compliant canna business

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Published by Simone Cimiluca-Radzins Designed by: Jean-Nicolas Bayette Tel: 310-909-9532 Email: simone@liv-consulting.com Website: www.280ebook.com © 2015 Simone Cimiluca-Radzins

The right of Simone Cimiluca-Radzins to be identified as the author of this work has been assessed by her in accordance with Copyright, Designs, and Patents Act 1988.

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means electronically, mechanical, photocopying, recording or otherwise, without either the prior written permission of the Publisher or license permitting restricted copying in the United States issued by the Copyright Licensing Agency. This book shall not be lent, resold, rented out or otherwise disposed of by way of trade in any form of binding cover other than that in which it is published, without prior consent of the Publisher.

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Table of Contents

Introduction .............................................................................................................................. 5 Cannabis 101 ............................................................................................................................. 9 Accounting 101 ...................................................................................................................... 13 This Thing Called 280E ....................................................................................................... 26 Cash is King ............................................................................................................................. 32 Final Thoughts: Starting Your Canna-­‐business .......................................................... 38

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“Know the rules well, so you can break them effectively.”

-Dalai Lama

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Introduction Who this book is for: This book is for people who: • • • • •

Know nothing about cannabis and finance Are curious about the green rush Are looking to get involved or are interested in operating a cannabusiness.

Have been running a canna-business, but need some help with the finance and accounting part of the business.

Understand how to operate a business but need some help with finance and accounting.

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Acknowledgements Like any entrepreneur, I’m irrationally optimistic. I truly believe that we all can accomplish whatever we want if we set our mind to it. However, one thing I’ve learned through my career is that it takes a significant amount of time and effort to achieve your goals. There’s no luck in the equation: it's hard work, grit, and passion.

I would like to thank my friends and family for your never-ending support and encouragement in my career as well as writing this book. I’d like to thank my business partner for giving me the opportunity to take on the New Era and my clients who have taught me the ins and outs of the industry. Lastly, thank you for reading this e-book. I hope you can apply some of these tools to your business.

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About the Author Simone Cimiluca-Radzins is a CPA with New Era CPAs and a founder of the Cannabis Finance Bootcamp. Simone’s expertise is in business strategy, finance, financial reporting, canna-accounting, 280E tax strategy, and risk management.

Simone has helped take companies public, performed due-diligences, and has helped companies improve their business operations. Simone has spoken at Women and Grow, appeared on 420 Radio, and has given talks at the University of Oregon.

With a background in Big 4 public accounting and international consulting for Fortune 500 companies, Simone has lived and worked in Spain and France and has assisted clients throughout Latin America, Western and Northern Europe, and the Asia Pacific region.

Simone holds an active CPA certificate from the State of Oregon and spends her time between Los Angeles, California and Portland, Oregon.

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The Cannabis Industry The cannabis industry is both literally and metaphorically green. Cannabis is the next great American industry, and there are an enormous amount of opportunities for entrepreneurs. Although federally illegal, cannabis is the fastest growing U.S. industry and estimated to reach $35 billion by 2020. The U.S. market for legal cannabis grew 74 percent from $1.5 billion in 2013 to $2.7 billion in 2014.1 Legal cannabis has created thousands of new jobs and has also helped states increase tax revenue. There is no doubt that it will continue to grow, and some experts say that it’s currently larger than the U.S. market for organic foods.

However, this booming and dynamic industry still has many hurdles, challenges, and paths to be paved. Because cannabis is federally illegal, canna-businesses face massive tax rates and additional liabilities resulting from Section 280E of the Federal Income Tax Code. In addition, over 80% of canna-businesses operate without a bank account, and the overall industry is fairly underdeveloped in terms of business regulation and guidance.

In this guide to running a successful and compliant canna-business, I will show you how to assess the financial health of your organization and implement tools and procedures to evaluate your operations. You’ll also get a guide to Cannabis 101 and learn cannabis specific accounting and finance principles.

There are a several illustrative examples in this e-book. These are meant to help you better understand the concepts and principles. Read this book at your leisure, and please re-read it because I guarantee you will pick up new information.

Knowledge is power and power brings options. By writing this book, I hope to spread my knowledge to anyone that is curious about business, finance, and the cannabis industry and open up your options.

Alright, let’s go!

1 According to the ARC group, a cannabis industry investment and research firm based in Oakland,

California.

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Cannabis 101 There’s business and then there is canna-business. This section is meant to give you a quick guide on the moneymakers in the industry and the main players. If you’re new to the industry and don’t know too much about cannabis, this section is perfect for you. If you’ve been working in the cannabis industry, you can breeze over this section.

The Money Makers Every business must sell a product. So what does a canna-business sell? Below is a summary of some of the main moneymakers of the cannabis plant from seedling to marijuana-glazed pecans.

Seedlings: Many growers buy seeds to start their grow. There are several strains of cannabis seeds to choose from, and breeders offer a variety of selections.

Clones: Clones can also be used for growing your marijuana plant. A clone is a cutting from a mature “mother” cannabis plant and can be replanted to grow another plant. Each cannabis clone is a genetic copy of its parent, so if the parent is a female, then you are guaranteed that all of the clones taken from that cannabis plant will be female.

Flower/Bud: After about 3-4 months (this is an average), the cannabis plant is ready to be harvested. After the plant has produced some fantastic flowers/buds, it must be trimmed, dried, and cured.

Trim: All of the plant material that is left over after harvesting and manicuring the marijuana plant is called trim. Trim can be used to make concentrates, tinctures (extracts), edibles, or hash.

Extracts: An extract is a highly concentrated cannabis oil that is made through an extraction process. The extraction process is truly an art form and requires an immense amount of knowledge and the proper equipment. Shatter, concentrates, tinctures, wax, oil, and crumble are all forms of extracts. Some extractions will be used to smoke, while others can be added to food and liquids, put into a cartridge, applied to the skin, or consumed directly in small amounts.

Edibles: Edibles are absolutely delicious and have matured beyond the weed brownies of the 1970’s. From cannabis infused ice cream and crème brulee to pot infused sodas and coffee, edibles represent a huge 9

percentage of revenue in the overall industry. In 2014, Colorado sold close to 5 million marijuana edibles in the recreational market.

Hemp: Hemp is part of the cannabis plant, and its products include fiber, oil, and seed. Hemp can be found in foods, oil, wax, rope, cloth, paper, and fuel. There are more states that have legalized hemp production than there are states that have legalized marijuana possession and usage.

There are other marijuana products on the marketplace, including cartridges for vape pens, pre-rolled joints, etc. All of these products would fall under the above categories. For example, a vape pen would be made with a pen and a cannabis cartridge. The cartridge would be from an oil or extract.

Now that we’ve got a good idea of the types of marijuana products on the market, let’s take a look at the major players in the industry.

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Understanding the players in the industry It’s essential to understand the players in the cannabis industry because not only do they do different things, but they may also have different legal, regulatory, and tax issues depending on which state they operate in. Each one of these players is unique in terms of their business model and selling proposition; however, all of them are interrelated.

Producer: A producer grows cannabis. Producer duties include harvesting, manicuring and drying/curing the marijuana plants. Depending on the climate, producers can have operations outside, in a greenhouse, or indoors. Producers can sell baby plants (clones) to larger growers or grow plants from seedlings. Producers mainly sell bud or trim to processors, wholesalers, or directly to the retailer. In smaller operations, growers can also sell directly to the end-consumer.

Processor: Processors can buy the bud or trim from the producer and process the marijuana into another form (i.e. extractions, edibles, etc.) A processor changes flower or trim into oil or wax. The processor will then sell it to a third party who will resell it or create another cannabis infused product (i.e. edible company). Producers and processors are often one and the same.

Manufacturer/Wholesaler: Manufacturers or wholesalers (the terminology depends on the state) buy the cannabis from a producer or processor and infuse the plant with another non-cannabis component. A manufacturer/wholesaler can also just resell the cannabis to a retailer.

Retailer/Reseller: A retailer is a brick and mortar (store front) or delivery service that sells the end-product to the consumer or patient. Other terms include dispensary, collective, and co-op. Depending on the state and local laws, retailers have certain restrictions on how they sell to consumers.

It’s important to remember that the business model for each of these players is different, and the state and local regulatory and licensing requirements are also different.

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Ancillary Business: Any business that supports the marijuana industry but does not produce or touch cannabis.

As you can see, there are many more players in the ancillary market than the businesses that actually produce or touch cannabis.

Final Thoughts and Takeaways There are three key takeaways from this section: 1. The cannabis industry is currently the fastest growing American industry.

2. The industry is underdeveloped in terms of business regulation and guidance.

3. There are many different players in the cannabis industry. Each one of them is unique in terms of their business model and selling proposition, but all of them are interrelated.

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Accounting 101 Less than fifteen years ago, telling someone in this industry to save their receipts was unheard of, but today it’s what everyone should be doing. Like I mentioned before, canna-businesses face more obstacles than other businesses and will be under the microscope and scrutiny of many local, state, and federal players.

Knowing you’ll be facing this battle, it’s essential that you stay in compliance.

If you want to operate a legitimate canna-business, stay in compliance with your local and state regulatory bodies, and in order to maintain your license to operate a business, you will need to report and record your numbers. Not only will reporting your numbers help you stay compliant, but it will bring your business more success.

You don’t need to be an accounting or business major, but if you want your canna-business to be successful, there are certain terms, metrics, and things you must know and do. This chapter is intended to give you the 50,000 foot view on accounting and business administration to give you the tools to get your cannabusiness set up for success.

If you’re the CEO of your canna-business, you need to know what your best product is, and you'll also need to know how much you are selling and spending each day. Knowing these metrics isn’t rocket science; it’s implementing the right tools.

Where do I start?

To start knowing your numbers, you’ll need an accounting system and a point of sales system. Once you’ve got these two things set up, you’ll be able to generate reports to help you monitor and track your sales, cost of goods sold, and other expenses.

What is an accounting system?

An accounting system is used to record activities of the business and includes sales, inventory, purchasing, and payroll expenses. Put simply, every transaction from paying utilities to registering a customer sale should be recorded in your accounting system. An accounting system allows you to manage your financial landscape; it lets you run reports, invoice customers, and pay vendors and employees. QuickBooks, QuickBooks Enterprise, Xero, and SAP are all forms of accounting systems.

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Seed to Sale Tracking If you’re operating in a state where cannabis is legal for adult use, you will be required to have a seed to sale tracking system as part of state licensing requirements. A seed to sale tracking system literally tracks the cannabis plant from the seed/clone at the producer level to the final sale at the retailer. If you’re operating a canna-business in a state where there is not a recreational market, you are not required to use these systems.

Currently, there are two major seed to sale systems: MJ Freeway: This business has three different inventory and sales tracking features depending on the role of the industry. These are only inventory and sales options and do not offer a full accounting system but do interface with QuickBooks: •

Producers: GrowTracker is designed exclusively for grow production and tracking management and manages the grow operation from seed to harvest.

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Processors and Manufacturers: MixTracker is designed for the manufacturing process such as edibles, concentrate, and extracts.

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Retailers: GramTracker is designed for the retail process and allows dispensaries to track every gram.

BiotrackTHC: This system allows you to manage inventory and sales through a single platform while giving complete visibility to state regulatory agencies.

BiotrackTHC assigns a unique 16-digit barcode to every seed and plant, so the entire life cycle of the plant is carefully monitored in order to determine areas that need improvement or are producing high yields. Growers can also monitor each plant down to the batch where it was originally stored and can pinpoint a plant’s exact location at any time.

BiotrackTHC also offers a customizable Point-Of-Sales System that tracks every transaction made at the dispensing facility. BiotrackTHC builds reports for accounting, customers, employees, inventory, and sales.

Point of Sales If you’re not operating in a state where seed to sale tracking is required, there are some alternative solutions that you may use to track your sales. Regardless, a POS system is a great way for you to track and analyze sales trends, product performance, and customer purchasing habits. Square, Apptivo, Paypal, and iPayment are popular POS systems for retailers that accept debit and credit cards.

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Here’s an overview of accounting and POS systems. Like everything, the systems range on price and degree of complexity.

Accounting Systems Here are some of my recommendations for accounting systems. These are applicable for all industries and are not just canna-specific.

QuickBooks Desktop or QuickBooks Online: QuickBooks is rated the #1 accounting solution for small to medium size businesses. It’s easy to use, and there are invoicing capabilities and monthly accounting reports to monitor operational and financial performance. QuickBooks desktop has a direct interface with MJ Freeway; however, QuickBooks online does not.

QuickBooks Enterprise: I recommend QuickBooks Enterprise for manufacturers and companies with a large inventories that are not using a seed to sale system. It’s a step up from QuickBooks and adds data capacity, has a more sophisticated inventory management, and supports multiple entities.

Excel Tracking: Depending on your size, sales and expense tracking in excel could be an option—assuming you’ve got a small business with very few customers, suppliers, and transactions. However, it won’t be as easy to analyze your financial landscape, determine sales trends, etc. You’ll have to be diligent, organized, and able to work with an outside bookkeeper to file your taxes.

Outsourcing: You can also opt to use a bookkeeper that will manage the accounting oversight process and accounting system. There are several online bookkeeping options that range from www.elance.com to www.bench.co. You can also use a local bookkeeping firm or a CPA.

Point of Sales Systems If your canna-business has a bank account that can accept customer payment via debit or credit card, I recommend the following POS Systems. Remember, POS systems that register debit and credit cards typically incur a transaction fee and can be used in an all cash environment.

Square: This is a mobile POS system that allows you to use your smartphone (android and IOS) to register sales anywhere. Square easily integrates into QuickBooks.

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Square Register: Square Register is part of Square but has more features such as offline payment processing, customizable items, realtime inventory tracking, and multiple users with one account.

Apptivo: Apptivo is a CRM (Customer Relationship Management) tool and a POS system. This system is great if you want to strongly manage your customer relationships. Apptivo interfaces with QuickBooks.

QuickBooks and QuickBooks Enterprise: Both of these Intuit products have invoicing and POS capabilities.

Receipt Books: With minimal sales transactions each month, providing your customers with paper receipts is another option to register your sales activity. It is easy to track and add manually to the accounting system.

Receipt books can be purchased at Staples or ordered online.

How do you know which system is right for you? It really matters on the size and complexity of your business, how many transactions you are having on a daily basis, and if you are operating in an environment where seed to sale tracking is required.

Chart of Accounts Smart decisions can only be made with clarity of the situation. Once you’ve decided on the best accounting system for your business, it is imperative that you create a chart of accounts and set up a clear invoicing structure for your customers.

The chart of accounts is a complete listing of every account in your accounting system. An account is a unique record for each group of business transactions.

Cash, sales, customer returns, Property, Plant, and Equipment (PPE), payroll expense, and rent expense are all examples of accounts in the chart of accounts.

Depending on your business model (producer, processor, manufacturer/ wholesaler, or retailer), your chart of accounts will vary. A wholesaler might have an account titled “Delivery Expense” for all expenses incurred for paying its drivers to deliver edibles while a processor might have an Equipment account for its extraction equipment. Most accounting systems will have a template chart of accounts that can help you with the creation process; however, I advise working with a CPA to determine the best chart of accounts for your canna-business.

Remember, nothing is set in stone. After you set up your chart of accounts, you might need to delete, revise, or add accounts for various reasons—which is totally fine. You may need to delete accounts that were created in error or revise accounts to add more detail, or create new accounts or sub-accounts as your business grows. This is an easy process and 100% doable.

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Invoicing Customers and Requesting Invoices from Suppliers In an accounting world, the more detail, the better. Detail means better decisionmaking, and better decision-making leads to more business and more money.

When it comes to invoicing, it’s the same. It is important for your canna-business to set up correct invoicing for your customers and request that your suppliers to do the same.

Which of the two scenarios leads to better decision-making?

INVOICE 1

INVOICE 2

Customer: Simone Date: December 31, 2016

Customer: Date:

Products 1 Gluten Free Edible – 20mg TH.. $10 2 Almond Bark -20mg CBD $40

Total

Edible @ $50

$50

Obviously, Invoice 1 is the better decision-making scenario. If you create an invoicing system, you will be able to track your sales by item and customer and easily determine when you need to replenish your inventory. Setting up your invoicing can be done in the accounting systems and POS systems mentioned above. Seed to Sale systems will require you to have this level of detail in your invoicing.

Choosing Your Accounting Method When you start your business, you will need to decide whether you’ll use the cash or accrual method of accounting for keeping track of your accounting. Let’s take a look at the difference between the two methods: Cash Method: Revenues and expenses are recognized at the time they are actually received or paid. You’ve invoiced your customer $20,000 but haven’t received the payment yet, so you won’t recognize revenue until you’ve received the cash.

Accrual Method: Revenues and expenses are recognized when the transaction occurs (even if the cash isn’t in or out of the bank yet) and requires tracking receivables and payables. You’ve shipped $20,000 of bud to your customer but haven’t received payment yet. You’ll recognize the revenue in the accounting system even though you haven’t received payment.

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I recommend the accrual method for companies dealing with inventory. It’s the method of accounting method most common for businesses earning more than $1M in revenue.

Final Thoughts and Takeaways There are three key takeaways from this section: 1. It is important to choose the right accounting solution for your current business operations and future growth expectations.

2. Stay organized and have good record keeping. This will not only help you make business decisions, but also allow you to have your ducks in a row in case of an IRS or other regulatory audit.

3. Save your invoices and all receipts. These are backups for your accounting records.

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Accounting Basics: The Income Statement In this section, we will learn the basics of understanding your financial results and the key accounting principles. Financial results are commonly known as the Profit and Loss Statement or the Income Statement.

Put simply, financial results mean how much money your company made (Revenue or Sales) and how much money was spent operating the business (cost of your product or service, costs associated with the rent, paying employees, vendors, etc.).

The net of those two is your operating profit before taxes and interest.

INCOME STATEMENT Sales - Cost of Goods Sold Gross Margin

COGS: is an important metric for your canna-business and for your annual tax filings. See Section 280E for more.

Gross Margin - Operating Costs Profit before taxes and interest

Profit before taxes and interest - Taxes and interest FINANCIAL RESULTS When you assess the financial results of your canna-business, there are several layers that must be analyzed. These include sales, gross margin, operating expenses, and your break-even point; in addition, cost of goods sold is also an extremely important metric for your canna-business.

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Sales When assessing the financial results of your business, knowing your sales performance each month is essential. Understanding your customer’s purchasing habits in terms of quantity, price, and frequency will allow you to focus production on profitable and in-demand items.

This section is dedicated to using the information in your accounting or POS system to make better decisions and to be able to answer this question: So, how are your sales?

Here are some questions you need to ask in order to understand your sales:

Question

Why you need to know

This allows you to eliminate non-selling products What are my top products by that are taking space on your shelves. sales?

Who are my top customers?

What’s my average sales per day?

What’s my average sales order?

What’s my most profitable product?

This allows you to focus on these customers, find similar customer profiles, and cater your product offerings to similar customers.

This will help you predict cash flow and know when to offer pricing discounts and sales.

This allows you to understand your customer’s purchasing behavior better.

This allows you to determine which product gives you the best margin.

When you know the answers to the above questions, you can make more informed decisions about your product mix, sales prices of your product, and the customers on which you should focus.

Excise and Sales Tax

One of the benefits of legalized cannabis to the state governments is the tax revenue collected on marijuana sales. The way they collect this revenue is through an excise or sales tax. If you are a retailer, you must collect this tax from the end consumer to remit or pay back to the state government.

In states where adult use of cannabis is not legal, canna-businesses serving the medical market are still required to collect sales tax on products if they are selling to the end-consumer (if there is a state sales tax). Most canna-businesses are not aware of this legal requirement.

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Cost of Goods Sold Cost of goods sold (COGS) is just what it sounds like. How much did each gram of marijuana, edible, vape pen (insert your favorite cannabis product here) cost to sell?

COGS is any expense that is either directly or indirectly involved in making your product or creating your service. Any and every expense that was incurred to get that product ready for sale is considered a cost of goods sold.

Cost of goods sold also includes direct costs such as labor to produce the product, supplies used to manufacture or sell, costs of containers, freight in, and overhead costs directly related to manufacturing or production activities (like rent and utilities). COGS is very important for any business but especially for the canna-business. First, COGS helps set product pricing and determines your gross margin. Let’s use an example:

Example 1: Cost of Goods Sold Imagine you’re in the edible business. Your company, Mary’s Space Cakes, was featured in the local newspaper last month and is the talk of the town.

You’ve decided to sell each one of your space cakes for $35. $35 seems like a reasonable number; it's cheaper than the competition, and it’s allowing you to get a lot of sales;1,000 cakes this month.

But how much does one of these cakes cost to make? You’ll have to add in the direct materials like trim, butter, flour, and eggs ($20); next, you'll add in the direct labor (how much you get paid to make 1 cake) of $30. Sum those two together, and the cost of goods sold is $50. So, is it wise to sell your cakes for $35? Definitely not, and here’s why:

Mary’s Space Cakes August Sales Sales Direct Materials (Trim, Flour, eggs, sugar, etc.)

Direct Labor Total COGS Gross Margin Gross Margin %

Individual Cake

1000 cakes

$35

$35,000

$20 $30 $50 -$15 -42%

$20,000 $30,000 $50,000 -$15,000 -42%

You are losing $15 for each time you sell one cake. It’s great you’ve sold $35,000 in July, but it cost you $50,000. You’re in the red - and the red is not a place you want to be.

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Knowing your cost of goods sold will allow you to set a pricing that will yield a positive gross margin.

Also, once you’ve determined your COGS, you can examine if there are ways to lower the costs. Contract negotiations with a major supplier and quantity discounts are some ways that companies reduce their cost of sales.

Need a few tips and tricks to understanding what your cost of goods sold is?

Check out this guide below:

Type of Business

Cost of Goods Sold

Producer

Cost to grow cannabis such as seedlings, nutrients, water, electricity, and overhead costs. Costs incurred for growers and related labor.

Processor

Cost to process cannabis product in another form, which includes cannabis purchased from producer, supplies used for extraction process, depreciation of processing equipment, cost of packaging and shipping, and overhead costs Cost of raw materials used to produce a product, supplies used in the manufacture process, cost of packaging, and overhead costs.

Manufacturer

Retailer

Cost of items purchased for resale and any additional cost incurred to further procure the product for re-sale.

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Gross Margin Gross margin is the difference between sales and cost of goods sold. CEOs, CFOs, and executives love this ratio, and you should too! Unfortunately, a lot of business owners and entrepreneurs aren’t familiar with the significance of this key ratio, and that is the main reason why 80% of businesses fail.

So we’ve established that gross margin is a very IMPORTANT ratio. But why?

This is an extremely important number for business owners to manage because it impacts the likelihood of reaching breakeven and making a profit. So back to Mary’s Space Cakes:

Example 2: Gross Margin After figuring out your cost of goods sold, you decided to change your sales price per cake to $60. Unfortunately, not everyone could afford that price, and you only sold 900 cakes in August, but don’t get too worried. Even though you sold less, you sold it at a higher price. Check out how gross margin changed:

Mary’s Space Cakes August Sales Sales Direct Materials (Trim, Flour, eggs, sugar, etc.)

Direct Labor Total COGS Gross Margin Gross Margin %

Individual Cake

900 cakes

$60

$54,000

$20 $30 $50 $10 16.67%

$18,000 $27,000 $45,000 $9,000 16.67%

Changing your sales price to exceed your COGS, gave you a positive gross margin of $10 for each cake sold compared to $-15. In August, your Gross Margin was $9,000.

So that means if all of your operating costs (rent, utilities, marketing expenses, salaries, etc.) are less than $9,000, you’ve made yourself a profit.

It seems like a very simple concept, but I cannot begin to stress how many business owners don’t analyze gross margin. Sometimes, cutting your sales price offers more sales, but if your sales price is too low, and direct costs are too high, then you will never break even.

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Another key performance indicator is the gross margin percentage. Taking the gross margin and dividing it by sales calculates gross margin percentage. It’s important to track each product’s gross margin percentage and compare it to your total gross margin percentage to understand your most profitable products.

Operating Costs Operating costs are all costs associated with running your business. This includes rent, utilities, salaries, administration expenses, travel costs, postage, printing, marketing, etc. It’s important to analyze what goes into these costs because there is often room to reduce them and increase profit.

The IRS doesn’t let canna-businesses working directly with cannabis deduct operating expenses, so it's essential that you’ve reduced these costs to a minimum.

Breaking-­‐Even When your sales can cover all of your costs (cost of goods sold and your operating costs) you’ve reached your break-even point. A break-even analysis lets you determine when your business will be profitable and how much of your product you will need to sell to make a profit. So how do you calculate breakeven?

Here’s how you calculate break-even points in units of production:

Example 3: Break-Even You’ve calculated that your fixed costs to operate Mary’s Space Cakes consist of its lease, depreciation of its baking assets, and property taxes. Those fixed costs add up to $10,500 a month.

We know from Example 1 that the variable costs to make a Space Cake are cannabis, baking materials, and direct labor. Variable costs (Direct Costs) have been calculated to be $50 a cake. Each cake sells for $60.

Given this information, we can calculate the breakeven point for Mary’s Space Cakes.

Fixed Cost/Price – Variable Costs = Break-Even Point $10,500/($50.00-$60.00) = 1,050 cakes to break-even You will have to sell 1,050 cakes a month to break-even with your current pricing and expenses.

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As a canna-business owner, you can see that any decision you make about pricing your product to customers, cost to sell or make your product, overall costs to operate your business, and the resulting quantity you must sell are interrelated.

If you’re starting up a canna-business, it is important to identify your expected startup costs to help you determine your sales price that you will need to pay ongoing business expenses.

Final Thoughts and Takeaways There are three key takeaways from this section: 1. Know your customers and products. Take a deep look at customer trends, purchasing habits, and product preferences.

2. Analyze your gross margin. Even though you’re selling more products, is your gross margin high enough?

3. Perform a Break Even Analysis to know how many sales you’ll need each month to cover your expenses.

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This Thing Called 280E There’s a little thing called 280E that has disrupted and imposed an unnecessary and costly burden to canna-businesses. This section is dedicated to understanding what 280E is, its impact to your business, and ways to minimize your exposure to it.

Tip: In this section, I will mention the words deduct and expense a lot.

REMEMBER that when you are recording your business activities in your accounting system, record EVERY business transaction (meals, entertainment, gas, selling, and marketing expenses) even if you can’t deduct it for your taxes.

What is 280E The IRS tax code 280E “Expenditures in connection with the illegal sales of drugs” prevents any company that is directly involved in selling cannabis from receiving the standard tax deductions that other businesses are allowed to take.

IRS tax code 280E allows cannabis producers, processors, manufacturers, and retailers to only deduct their cost of goods sold.

The IRS allows bakers, lawyers, and storeowners to deduct COGS, payroll, rent, gas, meals, and entertainment; however, canna-businesses do not have that same ability. In the example below, both Bob and Mary run bakeries, and Mary’s is subject to 280E.

Bob’s Bakery Products Sold

Baked Goods

Gross Revenue COGS Gross Income Gross Margin Percentage General and Admin Expenses Rent Expense Payroll Expense Net Income Taxable Income

$10,000,000 $700,000 $300,000 30% $75,000 $50,000 $20,000 $155,000 $155,000

Mary’s Infused Brownies Cannabis baked goods $10,000,000 $700,000 $300,000 30% $75,000 $50,000 $20,000 $155,000 $300,000

As you can see, Mary and Bob have the same net income, but Mary is paying significantly more taxes to the IRS because she can’t deduct her operating expenses. 280E puts canna-business at an unsustainable and unfair position because they are paying taxes on their gross income and not their net income.

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280E: When and Why Rewind back to the 1981. The cost of a gallon of Gas was $1.25, Lady Diana married Prince Charles, MTV was launched, and a drug dealer from Minneapolis dutifully filed his taxes, claiming all of his business expenses.

The IRS got wind, so they put their foot down and said, "Nope. Sorry, this isn’t going to fly." The result was IRC 280E. When it was originally enacted, anyone trafficking an illegal substance was not allowed to deduct any expense (not even cost of goods sold). Another case a decade later forced the IRS to recognize cost of goods sold as an allowable expense to take.

280E was enacted to punish drug dealers and is an unjust burden to legal and compliant canna-businesses. IRC 280E must be changed. In 2010, lawmakers in Arizona, California, Colorado, and Massachusetts sent a letter to the IRS requesting that it stop enforcing Sec. 280E. Most recently in July 2015, a federal appeals court in California ruled in favor of 280E, meaning canna-businesses still face the 280E burden.

So now that we know 280E is likely to stay for the next few years, let’s talk strategy.

A second glance at COGS There is no magic wand to completely avoiding 280E, but there are several tools to minimizing your 280E exposure.

The number one piece of advice on battling 280E is determining your COGS. COGS is calculated by the following formula:

PRODUCER or PROCESSOR

RESELLER or RETAILER

Beginning Inventory

Beginning Inventory

+Current year production costs

+Current year purchases

- Ending Inventory COGS

- Ending Inventory COGS

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The complicated part in calculating COGS is determining your costs. The IRS defines COGS as “any expenditure necessary to acquire, construct or extract a physical product which is to be sold. The seller can have no gain until he recovers the economic investment that he has made directly in the actual item sold.”

COGS is anything that directly or indirectly involved in making your product and must be directly or indirectly related to the sale of your product. So, let’s take these common examples of COGS in the cannabis industry: 1) If you are a grower and have a monthly lease payment for your greenhouse, the lease expense is an indirect cost to your product.

2) If you have machines to process trim into oil, the depreciation on those machines can be allocated to COGS. 3) If you hire trimmers or grow labor, that labor can be allocated to COGS. So what do you do about the cell phone bill you have each month or the gas you spend delivering your product to customers? Can you allocate these costs to COGS? Probably not, and here’s why: 1. Administrative costs such as cell phone, payroll for staff, gas, meals, entertainment, travel expenses, etc. cannot be allocated to COGS as these costs are not directly involved in making your product.

2. Selling costs such as marketing on weedmaps, trade shows, and paying commissions to sales staff cannot be allocated to COGS. These costs are directly related to selling your product or service and aren’t considered COGS.

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Revenue Streams 280E doesn’t allow expenditures in connection with the illegal sales of drugs to be deducted, but what about sales of products that aren’t illegal? Can expenses not related to illegal sales of drugs be expensed? Yes, but carefully.

Here’s an example:

Example 4: Different Revenue Streams Imagine you’re a wellness center in California and have three revenue streams in your business: 1. Selling Cannabis Products (bud, edibles, waxes, oils, etc.)

2. Selling non-cannabis vitamins and supplements (Echinacea, Turmeric, B12, etc.)

3. Performing physical therapy, massages, and spa services Here are a few more details: •

•

You’ve got 10 staff: o 2 dedicated to the cannabis business o 8 dedicated to only selling non-cannabis items and performing the spa and massage services All of the operations are in the same building, but separated by rooms.

What’s your 280E Strategy? (SERIOUSLY, think about this and then turn the page for my answer.)

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Example 4a: 280E Strategy with Different Revenue Streams Here’s my strategy. How did we compare?

1. The first strategy is documentation. If you’ve got three revenue streams, you need to make sure that your accounting records and chart of accounts reflect this.

2. Create three separate revenue accounts in your chart of accounts. a. Revenue – Cannabis b. Revenue – Vitamins and supplements c. Revenue – Physical therapy, massage, and spa services 3. The employees that work directly in the vitamin and physical therapy departments can be deducted because they are not involved in the cannabis business activities. Because you’re overseeing the entire operations, part of your salary will not be deductible. Tip: Define your employee’s roles and responsibilities through a contract.

4. The rent and utilities that are not directly involved in cannabis revenue stream can be deducted on your tax return. You will need to determine the amount of rent and utilities to allocate towards these revenue streams. Tip: I recommend performing a square footage analysis.

5. What about marketing and selling costs? You’ll have to document and determine what costs relate to which revenue stream. If they are clearly definable and supported as to not being related to the cannabis revenue stream, they can be deducted. Tip: Pay close attention to this step.

The CHAMP case paved the way to this strategy.

Understanding 280E isn’t difficult; however, setting up your business to minimize 280E is a bit more challenging.

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Final Thoughts and Takeaways There are 3 key takeaways from this section: 1. Any business selling cannabis is subject to IRC 280E and cannot deduct expenses other than cost of goods sold (COGS) from its federal tax return.

2. If your business has revenue streams that are not related to cannabis, then expenses associated with those revenue streams can be deducted.

3. Ensure you’ve got adequate supporting documentation to support your 280E strategy. Consult with a CPA or expert if you are unsure.

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Cash is King As long as you don’t have too much of it, cash gives you flexibility and peace of mind. However, having too much of it puts a business at risk for theft and misuse of funds. Plus, cash does not grow like other investments.

Eighty percent of canna-businesses operate in an all cash environment, and it’s not out of choice. Because they are insured and supported by the Federal Government, banks and credit unions are often hesitant to deal with anyone associated in the cannabis industry because cannabis is still federally illegal.

Unfortunately, that means most canna-businesses aren’t lucky enough to open a bank account and are forced to operate entirely in cash. There are several obstacles that canna-businesses face because they operate in an all cash environment, including the following items: 1. Protecting cash from theft and misappropriation 2. Operating a successful business 3. Not achieving a good return on investment on your cash This section is dedicated to operating an all cash business and creating controls to manage the risk of operating in an all cash environment.

As a canna-business owner, you must continue to work with your local legislature and cannabis activist groups to petition the Federal Government to change the banking requirements for canna-businesses and legalize cannabis.

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Internal Controls: Protecting your Cash Here are some internal controls you can implement in your canna-businesses to ensure you’re safeguarding and protecting your cash.

Restricting Access: Cash is liquid and one of the easiest assets to pocket. Depending on the size and type of your Company, the risk of employee theft of cash is different.

However, it’s a good practice to have at least three safes to store cash. You’ll want additional safes to store your inventory.

Safe 1

One safe can have daily cash amounts, and selected employees have access.

Safe 2

Another safe can have weekly amounts of cash to pay employees, vendors, and other expenses. Access to this safe should be different from the first safe.

Safe 3

A master safe should be located at an off-site location and only the owner(s) should have access to it.

Outside Security: Having a ton of cash, makes you a huge target for criminals. Depending on the size of your operations, you will want to consult with cannabis security firms to help with cannabis transportation, alarms, and armed security.

Cash Log: A cash log is a log for sums of money entering and leaving. Every purchase and replenishment to the cash log should be supported by a receipt or description of the funds. Include the date of the transaction, the vendor or employee, and the amount. The cash log can be done manually each day or can be entered into the accounting system if your business has the manpower and capacity to do so.

Cash Custodian: If your canna-business has multiple employees that will be handling cash throughout the day, then I recommend having them sign and attest to a cash custodian form. The form doesn’t have to be super-corporate; however, there is the significance of attesting that you will be responsible for your day’s cash.

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Daily Reconciliation: Reconciling your cash funds each day against sales and inventory is the best way to determine if the amount of your cash is correct. If you have multiple safes and locations where cash is stored, then I recommend reconciling those on a weekly basis.

Cash Counts: At least once a month, perform a full cash count and update your accounting records accordingly. It’s good to have two people at different levels perform this.

Operating Successfully in Cash To operate your canna-business successfully in cash, you will have to do these three things: 1. Get as comfortable as you can with cash 2. Account for everything 3. Forecast your cash inflows and outflows

Get as comfortable as you can with cash Even the Justice Department recognizes that operating an all cash business is risky, but you’ll need to find some level of comfort to operating your cannabusiness if you want to be successful.

Most vendors and employees will accept cash for payment, and you can hopefully use paying in cash as a competitive advantage or negotiation tool to receive discounts. Many businesses sell to their customers on credit and receive payment as late as 90 days later; you obviously won't be one of them.

For those vendors that don’t accept cash, continue to negotiate with them and open your eyes to their competition. Ironically, the IRS did not accept non EFT (electronic fund transfers) for tax payments until June 2015 and would penalize the legitimate canna-businesses that were paying their taxes. If the IRS can accept non-EFT payments, hopefully your vendors will too.

Account for Everything Operating in cash makes it harder to account for everything and stay transparent; however, cash transactions should not affect how you are operating the day-today activities of your business.

You will have to be diligent in keeping receipts for all of your expenses and purchases and accounting for them on a timely basis. Receipts are easy to lose, and when you don’t have a bank statement to reference, recording the expense will be difficult if you’re not organized.

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As a canna-business, you’ll be under the eye of several regulatory bodies: the IRS and tax entities, the local regulatory licensing bodies overseeing legal marijuana, and the general public. Save your receipts, keep your records up to date, and stay compliant.

Cash Forecasting It is crucial that you can forecast how much money you are going to be spending in the next week (cash outflow) and how much money you plan on making (cash inflow). This will help your business stay successful and ensure you’re able to order your product and pay your bills and employees without worry.

The examples below show you how to do a cash forecast.

Example 5: Cash Forecasting You opened your dispensary last month, and sales have been killer. Each week you’re making about $50,000. You’re depositing most of your sales in an off-site safe.

Next Wednesday you have to pay for inventory ($30,000) and payroll ($10,000) on Friday.

Today is Sunday morning, and you’re determining how much money you’ll need for the next week. You just checked the safe in the dispensary, and you have $500 (you thought there was a bit more…)

What do you do? And how much cash do you need?

SERIOUSLY, think about this and then turn the page for my answer.

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Example 5a: Cash Forecasting Strategy Here’s my strategy. How did we compare?

1. My first strategy is determining how much cash we plan to receive (cash inflow) for the next week. If we are doing about $50K per week, that’s an average of $7K a day.

2. My next step is to determine how much cash we plan to spend for the week (cash outflow). I know cash spend is forecasted to be $40K ($30K on Wednesday and $10K on Friday).

3. My next step is to determine if I’ll need to replenish or refill my current cash on hand at the dispensary from a safe offsite. We start with $500 in the safe.

Here’s how the forecast looks for each day:

Total Cash Available Inflow Outflow Total Ending cash

Sun 500

Mon 7,500

Tue 14,500

Wed 21,500

Thur -1,500

Fri 5,500

Sat 2,500

7,000 -

7,000 -

7,000 -

7,000 -30,000

7,000 -

7,000 -10,000

7,000 -

7,500

14,500

21,500

-1,500

5,500

2,500

9,500

4. It looks like our cash inflows don’t cover our cash outflows for the entire week. On Wednesday, we’re short $1.5K. 5. We've determined that it’s good to have a cash buffer on hand of about $2K at the store in case of emergencies.

Here’s how the forecast looks starting with $500 in the safe and a mandatory $2K buffer each day:

Total Cash Available Inflow Outflow Buffer Total Ending cash

Sun 500

Mon 7,500

Tue 14,500

Wed 21,500

Thur 2,000

Fri 9,000

Sat 6,000

7,000 7,500

7,000 14,500

7,000 21,500

7,000 -30,000 3,500 2,000

7,000 -

7,000 -10,000

7,000 -

9,000

6,000

13,000

With knowing we have a mandatory $2K buffer each day, we can forecast that we will need to bring $3.5K to the dispensary on Wednesday to cover the inventory purchase. If we bring the $3.5K, the total ending cash for the day will be our required buffer of $2K.

As you can see, forecasting your cash inflows and outflows is important to determine the amount of cash you’ll want to have onsite.

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Final Thoughts and Takeaways Here are the 3 key takeaways from this section: 1. Safeguard your cash. It’s important to implement internal controls over cash to prevent misappropriation of funds or theft.

2. Cash transactions should not affect how you are operating the day-to-day activities of your business.

3. Know your numbers. Ensure that you are recording every expense regularly and performing a cash forecast.

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Final Thoughts: Starting Your Canna-business Congratulations for being part of and taking interest in one of the most revolutionary and dynamic industries of the century. The growth is unprecedented, and the waters are unchartered! How exciting it is that you’re going to be involved!

The tips and strategies that we’ve discussed in this book will give you the foundation to navigate through the uncertainties of the cannabis industry. We’ve covered Cannabis 101 and have discussed choosing the right accounting system for your canna-businesses. We’ve examined canna-accounting principles and have examined navigating through IRC 280E. Finally, we’ve covered some tips to operating in an all cash environment. If you apply these tools, you will see a definitive and positive change in your canna-businesses.

I ask one thing of you, please continue the fight for legalization on a federal level.

Until cannabis is removed from it’s classification as a Schedule 1 drug, it will remain federally illegal, which means the issues with IRC 280E and banking will still exist. Get involved with local cannabis groups in your community and be the change you would like to see.

Best of luck and welcome to the Green Rush!

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Description In clear, easy-to-follow language with industry specific examples, Simone Cimiluca-Radzins covers Cannabis 101, an intro into canna-accounting, navigating through IRC 280E, and operating an all cash business.

Written for canna-businesses, self-employed individuals, employers, entrepreneurs, professionals, and those interested in the dynamic and burgeoning cannabis industry.

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