Cannabis COGs Optimization Can Boost Your Bottom Line
COGS stands for “Cost of Goods Sold.” It refers to the direct costs associated with producing and delivering a product or service. COGS is an important financial metric for businesses, as it helps to determine the gross profit margin of a product, a key indicator of overall profitability. It is also the most significant expense line item on your profit and loss statement – up to 50-60% of revenues– so taking the time to optimize your strategy can have a huge impact on your bottom line!
Since 280E restrictions limit what Cannabis businesses can deduct, COGS optimization should be the first area to tackle if you want to improve cash flows. Even a 5% optimization can result in hundreds of thousands of dollars in savings. When it comes to cannabis, purchasing and shrinkage are the two key COGS components to look out for. Below you’ll find the strategies our CPAs have outlined that you can use to optimize your purchasing and reduce your shrinkage costs.
Refining Purchasing Reduces Cannabis COGS
Here purchasing refers to the process of buying goods or materials that are needed to produce a product or service. When a business purchases materials, the cost of those materials is typically included in the COGS. The more materials a business purchases and the higher the cost per material, the higher its COGS will be. Effective purchasing strategies can help minimize the cost of materials and thus reduce COGS. Some strategies that cannabis operators can use to optimize purchasing include:
1. Instituting a product placement or shelving fee: Negotiating a discount from suppliers in exchange for prime real estate can offset the cost of purchasing. Brands routinely spend between 5%-20% of revenues on marketing, and product placement is a key marketing strategy. While a supplier can’t deduct marketing expenses on their taxes, they can deduct a discount – you save money on product costs, and they save on taxes. If you’re interesting in additional methods for offsetting marketing costs, you can check out this video all about COGS and marketing.
2. Implementing inventory management systems. Dialed-in Inventory management systems better track inventory levels and prevent stockouts. This can help operators optimize purchasing by ensuring that they purchase the right amount of materials to meet demand without over-purchasing and tying up valuable capital.
3. Conducting regular cost-benefit analyses. Cannabis operators can regularly review their purchasing strategies and conduct cost-benefit analyses to identify areas for improvement. This can help to ensure that the operator is purchasing materials at the best possible price and in the right quantity to meet demand.
4. Enacting price protection strategies for new brands/suppliers. If you are a retailer, you assume a lot of risk when taking on a new brand. A majority of retailers have inventory backlogs of brands and SKUs that don’t sell. For new brands try purchasing on consignment so that you only pay once the products sell.
5. Focusing on analytics based purchasing. Purchasing decisions are often based on anecdotal evidence, which can lead to stockpiles of poorly performing inventory. Therefore, operators can reduce purchasing costs by creating metric-focused standard purchasing procedures based on historical sales and inventory aging.
Even with the best inventory management system, one of the main issues that dispensaries encounter is purchasing and storing inventory that they are unable to sell in a timely manner du to changes in the market, customer preferences and amount of competition. This inventory ends up stockpiling in inventory accounting on the Balance Sheet, making their Profit & Loss statement look healthy at first glance, since the inventory is not counted as a “Loss,” but instead records as an asset on the Balance Sheet. But the reality is, if that inventory has not sold for an extended period of time, it should no longer be considered an asset. The cash tied into that inventory could be put back into business operations to purchase products that are popular and sellable.
The question becomes, how valuable is this asset really if it hasn’t sold for 60, 90, or even 120 days? The only way to assess the damage is to review – or implement – an inventory aging report which will detail how old the inventory is. Certain point-of-sale (POS) systems are able to produce inventory aging reports. If not, one can be created.
Don’t Let Shrinkage Eat Away Your Profits
Shrinkage, on the other hand, refers to the loss of inventory due to theft, damage, or other causes. When inventory is lost due to shrinkage, the cost of that lost inventory is effectively added to the COGS (a 2-4% increase on average!), as the business will need to purchase new materials to replace what was lost. This can increase the overall cost of producing a product or service, and can reduce the profitability of the business. Minimizing shrinkage can help to reduce the amount of lost inventory and associated costs. Some strategies for reducing shrinkage include:
Inventory Shrinkage Strategies
1. Conducting regular inventory audit. Cannabis operators can conduct regular inventory audits to identify areas of shrinkage and take corrective action. This can help to identify the causes of shrinkage, such as errors in tracking or theft, and implement measures to prevent future shrinkage.
2. Improving training and procedures. Cannabis operators can improve training and procedures to reduce shrinkage. This may involve training employees on proper inventory management, implementing procedures to prevent errors, or developing a culture of security and awareness.
3. Ensuring proper storage conditions. Ensuring that materials and products are stored in proper conditions can prevent spoilage or damage that may contribute to shrinkage. This may involve implementing temperature controls, proper packaging and labeling, and other measures to ensure the quality of materials and products.
By effectively managing both purchasing and shrinkage, a business can help to optimize its COGS and improve its overall profitability. For more tips and help with implementation, reach out to our team of financial experts at GreenGrowth CPAs. We are here to help your cannabis venture through any level of the accounting, tax filing, or business cycle.
We employ several financial programs to assist the company with its fiscal responsibilities, including tax planning and compliance, accounting & finance support, audit preparation, tax controversy support, and much more.