This index of the financial accounts in your general ledger saves time and stress when tax season rolls around.
Maintaining a clear, well-organized financial record is fundamental to any successful business, particularly within the complex and highly regulated cannabis industry.
Cannabis operators have a lot to keep track of. From staying compliant with complex regulations to tracking KPIs and staying alert for signs of embezzlement, running a cannabis operation involves wearing many hats.
A tool that can make your job easier is a proper Chart of Accounts (COA). This financial structure provides a strong foundation for easily managing and tracking your accounts, cash flow, and tax responsibilities.
In this guide, we delve into:
- How a COA can generate better, more accurate reporting on your cannabis business performance to help you grow.
- the steps to create a cannabis-specific COA,
- the potential hurdles and solutions to overcome them.
Our goal is to empower cannabis business owners with the knowledge to make informed decisions that will drive their business growth.
Understanding the Chart of Accounts (COA)
A Chart of Accounts is an index of the financial accounts within an organization’s general ledger. It is the backbone of your accounting system, offering a structured view of the financial transactions transpiring during a specific accounting period.
The COA simplifies the tracking of financial transactions, categorizing them into five primary groups: assets, liabilities, equity, income (or revenue), and expenses. These categories are further subdivided into smaller accounts to provide more granular detail.
For instance, under ‘assets,’ you may have accounts like:
- Cash
- Inventory
- Undeposited funds
- Vehicles
- Insurance
- Accounts receivable
- Buildings
- Other equipment
This structured overview of financial activities allows for better reporting and insight into your business’s financial health. Moreover, it ensures that your financial statements comply with the stringent reporting standards of the cannabis industry, making tax season a less daunting prospect.
The Necessity of a Cannabis-Specific COA
While the concept of a COA is universal across industries, the cannabis sector presents unique challenges and considerations. These include complex regulations, tax implications, and industry-specific factors, all necessitating a cannabis-specific COA.
The cannabis industry operates under stringent regulations, with businesses often facing heavy scrutiny from financial and tax authorities. A well-structured COA can help navigate these complications, ensuring compliance and transparency in financial reporting.
Moreover, Section 280E of the IRS code limits cannabis businesses to deduct only their Cost of Goods Sold (CoGS) from revenue on their tax returns. Therefore, classifying expenses correctly within your COA is essential to maximize your deductions and minimize your tax liability.
Furthermore, a detailed COA helps cannabis operators keep track of their deductible and non-deductible costs, identify opportunities for cost savings, and assess their business performance more accurately.
Building a Cannabis Business COA: A Step-by-Step Guide
Crafting a tailored COA for your cannabis business involves a series of steps, each requiring careful consideration of your business specifics. Here’s a step-by-step guide to help you build an effective COA:
- Structuring Your COA: Start by structuring your COA to suit your financial management needs. Aim for a system that delivers the metrics you need to run your operation effectively throughout the year.
- Defining Gross Margin: Gross margin is your profit after direct costs. Ensure you represent your direct costs correctly, keeping with your business specifics.
- Defining Indirect Costs: Indirect costs are overhead expenses related to your sales but not traceable to a specific product. Some of these costs can be listed as CoGS, so give this category special attention.
- Organizing Operating Expenses: Your COA should match the accounts and expense categories required for your cannabis business’s reporting. Align your expense categorization with your management team’s preferences.
- Using Account Numbers: Implement a numerical system for your account categories. A common practice is using 10000s for assets, 20000s for liabilities, 30000s for sales, etc. This system aids in quick referencing and efficient organization.
Remember, your COA should be as clear, functional, and user-friendly as possible. Collaborate with your accounting team and CPA to ensure your COA fits your unique business requirements.
Cannabis-Specific Considerations for Your COA
Creating a practical and manageable COA requires a balance between detail and simplicity. While it’s crucial to break down some categories, like wages, into separate accounts by job title or position, other categories, like office supplies, can be kept broad.
For a cannabis cultivation business, for example, your wage breakdown might include separate accounts for grow contractors, growers, trimmers, packaging, and sales, each with their associated wages and payroll taxes.
Moreover, your COA is a living document that should evolve with your business. Annual reviews with your CPA can help identify new accounts that need to be added or existing ones that need to be further broken down. Regular updates can help you optimize tax advantages and keep your financial tracking efficient.
Navigating the Federal-State Legal Paradox
While cannabis might be legal in some states, it remains illegal under federal law, classified as a Schedule I narcotic under the Controlled Substances Act (CSA). This federal-state legal paradox presents unique challenges for cannabis businesses, especially regarding taxation and financial reporting.
Section 280E of the Internal Revenue Code denies tax deductions for expenses incurred in trafficking controlled substances, including cannabis. However, it allows for the deduction of the Cost of Goods Sold (CoGS), making it essential for cannabis businesses to classify their expenses correctly.
A well-structured COA helps businesses follow regulations and maximize tax deductions, making it easier to navigate challenges.
The Risk and Reward of a Cannabis Business COA
Building and maintaining a comprehensive COA is no small task, especially in a complex and highly regulated industry like cannabis. It requires time, effort, and a deep understanding of your business operations and the industry’s financial landscape.
However, the rewards can far outweigh the challenges. A well-structured COA can enhance financial transparency, improve reporting accuracy, and simplify tax preparation. It can help you identify cost savings, optimize tax deductions, and provide valuable insights into your business performance.
A cannabis business COA is not just an organizational tool; it’s a strategic asset that can drive your business growth.
Conclusion
Accounting and financial management in the cannabis industry can be complex, fraught with regulatory hurdles and potential pitfalls. This complexity necessitates the involvement of accounting professionals and specialized services.
Additionally, accounting software like Quickbooks and Xero can aid in managing and tracking your accounts. However, they do not come equipped with a cannabis-specific template, further emphasizing the need for professional services.
A CPA with industry experience can help you create a cannabis COA that meets your business needs. At GreenGrowth CPAs, we provide guidance on managing finances, planning taxes, and following regulations. Our goal is to make it easier for your business to navigate the industry.
