Superior Financial Reporting is Crucial to Cannabis Business, by Hifi Farms CFO Andrew Hunzicker
Superior Financial Reporting is Crucial to Cannabis Business. Top 5 Reasons Why It’s True
#1) It’s the Law
Under IRS code section 280E, accrual accounting (as opposed to cash accounting) is required unless explicitly stated otherwise in the code. Additionally, only Cost of Goods Sold (COGS) can be deducted from income for federal tax reporting, and the IRS has issued a narrow definition for what can be included in COGS. See more information on 280e here.
Additionally, new Oregon state guidelines (see below) require detailed, accurate, and complete financial reporting. 845-025-1200 Financial and Business Records In addition to any other recordkeeping requirements in these rules, a marijuana licensee must have and maintain records that clearly reflect all financial transactions and the financial condition of the business. The following records must be kept and maintained for a three-year period and must be made available for inspection if requested by an employee of the Commission:
(1) Purchase invoices and supporting documents for items and services purchased for use in the production, processing, research, testing and sale of marijuana items that include from whom the items were purchased and the date of purchase;
(2) Bank statements for any accounts relating to the licensed business;
(3) Accounting and tax records related to the licensed business;
(4) Documentation of all financial transactions related to the licensed business, including contracts and agreements for services performed or received that relate to the licensed business; and
(5) All employee records, including training. Stat. Auth.: Sections 2, 12, 14, 15 and 16, Chapter 614, Oregon Laws 2015 Stats. Implemented: Section 46, Chapter 614, Oregon Laws 2015
Finally, the banks that are allowing banking in this industry are also requiring detailed quarterly financial statements and support.
#2) Good Accounting and Reporting Increases The Value of Your Business.
Companies that maintain a strong finance department are simply worth more money. A strong finance department is one with these characteristics: produces accurate, timely, complete financial statements, a robust Internal Control System including proper segregation of duties and safeguarding of key assets, detailed Accounting Policies and Procedures, electronic storage of all documents (invoices, sales receipts, bank records, etc.) that are readily available (i.e. on a secure storage site such as Dropbox), good dashboard and key performance indicators, timely cash and tax forecasting system, and a high level CFO (can be outsourced part-time) that designs the systems, reviews the work, participates in strategic decisions, acts as a sounding board for tough decisions, and assists as liaison with legal, tax, accounting, audit, IRS, acquirers, and other third parties. A secondary part underlying a strong finance function will be selection and use of the proper software (operations and accounting) tailored for use in the cannabis niche and selected based on size and complexity of your business.
Companies with these systems in place have better access to capital (bank, debt, equity), better reporting and relations with investors, get higher valuations at exit, makes due diligence much easier (for mergers or exits), and can ease the pain of an IRS or state audit.
#3) Lessen the burden of an IRS or State Audit
It is well known that cannabis related business are especially prone to IRS audit flags and it should not be a surprise to find your company selected for an audit sometime in the next few years. Usually the audit notice will arrive and will cover a period of time two to three years prior to the notice. This means that you have fewer worries if you have followed guidance in #2 above and the process should run smoothly and without penalty. However, if your company did not maintain a set of good accounting/finance policies and procedures, this audit could become your worst nightmare, which will take huge amounts of time and effort and can result in large fines or worse. Trying to get the documents and items they want that are more than two years old can be easy (if done right) or can take enormous effort and time (if a poor finance system is in place).
#4) Good financials allow you, the CEO, to make better strategic decisions
Accounting is often said to be the “language” of business and yet many CEO’s put low importance on the accounting, finance, and reporting function. Strong accounting and reporting allows the CEO to know exactly where he/she stands today, to forecast growth and cash in the next 12 months, and better make key strategicdecisions such as opening a new location, making an acquisition, or hiring more staff. Additionally it makes it easier to obtain financing from lenders or investors as well as keeping them up to speed with timely financial reporting.
#5) Increase your value at exit
At some point, you will likely want to exit your business. This could be a full company sale, or maybe you just want to buy out or sell to a partner, or maybe a divorce is forcing an exit, or many other possible events. When this happens the business will need to be valued and often times audited as well, and at the very least extensive due diligence. If you have very detailed, accurate and complete financial records and systems, this will maximize the value obtained. However, when incomplete or inaccurate items are uncovered the valuation will start to go down, and the more “issues and problems” uncovered, the steeper the discounts will be on final company valuation.