Did you know that COGS/inventory account for up to 50% of a Profit & Loss Statement for a dispensary? This is the biggest overlooked opportunity by most cannabis operators. Inventory management is so important and can have a direct effect on lowering operating costs. Learning how to optimize your COGS and inventory costs by looking at your aging inventory will ensure that your dispensary is turning the highest profit.
In this case study, we will blend a real-life problem one of our clients encountered while reviewing their aging inventory along with detailing steps every Purchasing Manager should be taking for proper inventory optimization. Let’s take a closer look at how to determine and optimize costs of goods sold to ensure that you are receiving the most revenue possible for your cannabis dispensary.
Thin Margins Hurting Cannabis Retailers
One of the main issues that dispensaries encounter is purchasing and storing inventory that they are unable to sell in a timely manner. 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.
In the circumstance we will reference for this article, our client came to us with hopes of creating and understanding an inventory aging report to produce an accurate count of how much money they had tied up in inventory. Their goal was to get help deciding which products to move and how to move them without losing too much profit.
Benefits of Implementing Inventory Aging Reports
When we initially created and reviewed our client’s inventory aging report, we saw that over a three month period, when filtered by Decrease by Category & Decrease Trends (negative inventory adjustments), there was a $7.6K to $12K jump in dollar amount tied up in inventory.
In other words, our client went from ~$15.2K to ~$24K (assuming a 2X) in lost revenue if the product was not stuck in inventory. This came out to 5%+ of sales, a big impact on profit margins, considering most dispensaries operate at 5-10% margin after tax, so fixing this alone can double after tax margin.
Dollar-wise, it was also a significant number: at $12K x 12 months = $144k. The dispensary did $180K per month in sales, signaling a lot of potential waste and theft for a relatively small operator. Knowing that most cannabis retailers have this issue, the losses for an operator with $600K-$1M in monthly sales will be enormous.
In this case, we recommended that our client review their inventory aging report with a few different filtered visuals, specifically by category and trends to determine how and what inventory to move. Let’s take a closer look at the outlined steps that should be required for every Purchasing Manager at a cannabis dispensary and see how they helped our client.
Optimal Cannabis Inventory Control SOPs
To begin, you will need to consider Inventory Control Standard Operating Procedures (SOPs).
First, you want to ensure that there is enough inventory in stock to match demand. On the other hand, it is equally important to not have too much money tied into inventory stock. This is a delicate balance that retailers at all levels struggle with.
For example, let’s say our client had $80K in “90 day plus” inventory. This means they had $80K of cash stuck in inventory that was not selling. The goal here would be to sell this inventory as soon as possible to unlock that cash so it can go back into business operations, like purchasing $80K worth of inventory, that will sell quickly to generate the business $160K (assuming a 2X markup).
To achieve this, we recommend team members involved in the inventory process follow the SOPs detailed below:
Purchasing Cannabis Inventory SOPs
Each week, the Purchasing Manager needs to analyze every product to find the low stock products to order one month supplies. Reviewing important inventory indicators, like historical trends, planned promotions for the month, etc. should be taken into account by the Purchasing Manager when determining which products to order. Products that are aging and expiring (60+ days old) should not be purchased or purchases of that product should be significantly reduced.
For products that are purchased on a monthly basis, the following information should be considered:
- Lead time – Lead time will be the time (number of days) expected between creating a Purchasing Order, submitting the order, and receiving the items in stock.
- Safety – Safety will account for the absolute minimum number of days of stock you wish to maintain for a certain product.
- Projected monthly sales 30 – This will be: Current Inventory x 30 / Projected Monthly Sales. If this number is less than Lead time + Safety, then a new order should be placed.
- The Purchase Budget – Ending Inventory (Safety x Projected Monthly Sales/30) + Projected Monthly Sales – Current Stock on Hand
Receiving Cannabis Inventory SOPs
When receiving inventory, the Inventory Manager needs to:
- Make sure it’s a 3-way match – ensure that the amount and final price match the purchase order, bill, and stock receipt.
- Count the stock to verify that the quantity received matches the documentation.
- Do a quality check – check each item is ready for sale.
Cannabis Storage and Control SOPs
Cannabis products need to be stored safely and at the appropriate temperature. Regular cycle counts need to be done in order to keep inventory management on track.
Each set of products needs to have an established Cycle Count, which will establish if you have a loss in inventory. This will happen due to poor inventory management policies, i.e. inventory that is miscounted or stolen. An employee needs to do a blind count of the inventory and document the amount of each product. Employees also need to perform an inspection and determine which products expire first; these products then must be sold first. Any cannabis item that has expired must be discarded and marked as a loss. Any discrepancies must be reconciled and documented as a loss in the online inventory system.
GreenGrowth CPAs recommended a Cycle Counts for our client that should be taken on a weekly basis. We also encouraged them to establish a KPI to keep the inventory discrepancy under 1%.
Every cannabis establishment should have adequate security in place to prevent theft – security and cameras should do the trick. To take extra precautions, ensure that every employee signs a theft policy with rules in place outlining what can happen if they steal. Employees should also have the anonymous right to report theft.
Cannabis Inventory Aging SOPs
Analyzing Inventory Aging should occur weekly. Referring back to our case study, $29K or 34% of our client’s inventory was aged over 60 days. That means that they had $29K of cash tied up in inventory, something that was not reflected in the Profit/Loss statement, but in the Balance Sheet, which was very misleading to the owner.
The Purchasing Manager needed to diagnose the inventory symptoms by running an inventory aging report. Cannabis products that are 60 days or older, or close to expiring, should be discounted and sold as quickly as possible. The Purchasing Manager should also note which products are not selling and remove them from inventory or order less next time. Below are a few ways to eliminate aging inventory:
- Re- Market Your Products: Try positioning these products in a different spot than before where they can be seen more clearly.
- Expose your Products Multiple Times: Try placing your products 2 or 3 different places throughout the store. Maybe include them at the register so customers can see them when they check out.
- Offer Discounts on these Products: This tactic must be done strategically. You have to gradually discount your products so that you aren’t completely losing sale on new products. For example, products that are 6 months old can have a 40% discount, while products that are 1 year old may have a 80% discount.
- Hold a Sales Event: Putting together a flash sale event may be a good solution to get rid of the product quickly. Flash sales encourage urgency from customers which leads them to purchasing products that they may have not even considered.
- Bundled Product Offerings: Grouping together aged products to sell at a discounted price as opposed to being sold more expensive as separate items will increase sales without taking a large hit on profits.
- Give Away Free Items: Giving away free cannabis products always gives a customer more of a reason to purchase something. Some states do not allow cannabis products to be outright given away for free. Many dispensaries will offer free joints (low-cost products) or a joint for a penny with the purchase of any product.
- Employee Incentives: You can get your employees involved to help move the aged products. You could offer them free/for a penny joints with every aged product moved. Having employees talk about the slow-moving products will also help sales.
- Return or Exchange Products: Work with your suppliers to see if they are open to exchanging products or offering a refund for products that are not sold. You also may want to set up a Price Protection Agreement with vendors. This could look something like: after 4 months, we will offer a 30% discount on this product which will give us a 30% refund on the product cost.
The Plan We Implemented with Our Client
The game plan we recommended for our client was as follows:
- Create a heavily discounted sale to free up cash that can be reinvested into new inventory, i.e. even 25-50% off. This is something big clothing retail chains do. You could even use a formula: i.e. 60 days aged 20% discount, 90 days 30% discount, etc.
- Revise the purchasing policy by leveraging sales through brand/category reports so that you don’t have inventory that is tying up cash, and on which your PL will have to take a hit since it will be heavily discounted. Items with no sales should not be purchased anymore.
- Review sales by brand, category, or product. In this case, we did category from largest to smallest. Categories are going to play a big part in inventory aging, so it’s important for a Purchasing Manager to evaluate inventory by each category. We divided the underlying products between high, mid, and low tier priced products to see how the volumes are moving in relation to price.
- Set up price protection arrangements with key vendors and suppliers.
The processes detailed above only address the symptoms of an inventory aging problem. For instance, 4 months from now a dispensary could still end up in a situation where there is $100K in aging inventory.
The true solution resides in purchasing procedures. Dispensaries must buy proper inventory that has high sell through rates. This is where purchasing SOPs come into play. The Purchasing Manager needs to be looking at analytics and data when making purchasing decisions i.e. what brands sell, which ones don’t sell.
Over time, a Purchasing Manager will improve based on historical data and analytics if they are reviewing inventory aging reports correctly. The ultimate goal is for a dispensary to have a detailed Standard Operating Procedure for inventory.
Final Thoughts
In serving the cannabis industry, the Outsourced CFO experts at GreenGrowth CPAs encounter issues like this all the time. The benefit of our deep experience with the cannabis industry is we have existing SOPs and procedures we customize and implement for our clients.
Every operation, market, and situation is unique. If you’re not seeing the profits you know your cannabis operation is capable of, reach out to us for a consultation.