The cannabis market is expected to grow exponentially in the coming years. But the near-term outlook is not so rosy in several well established markets. Cannabis operators in California, Colorado, Oklahoma and Oregon (just to name a few) are struggling with declining flower prices. They also experience challenges with decreases in customer demand, and the ever-present issues navigating onerous tax and regulatory burdens. In response, we’ve been helping our clients implement a variety of operational and financial and tax mitigation cost-saving strategies to help endure difficult market conditions.
In the following we’ll share some key ideas on how you can lower overhead and optimize operations to endure market downturns.
The number one reason cannabis businesses fail
If you’re reading this, you probably already know the answer… cash flow. According to a study by Business Insider, 82% of small businesses fail due to cash flow issues. The other top reasons are all also connected to cash flow issues:
- 79% fail due to a lack of start-up money
- 78% fail due to an insufficient business plan/operational model
- 77% fail due to unrealistic product pricing strategies
- 73% fail due to inaccurate estimations of sales, operating costs, and profit margins
- 70% fail due to an unwillingness to recognize or accept operational or financial failures
The Business Insider study focused on small businesses in all industries, but anyone who knows the cannabis operating environment will recognize these same issues are just as, if not more prevalent in the cannabis industry. Cash is king. Cash is the fuel your business runs on and nearly any turnaround or recovery strategy will be focused on managing and improving your financial situation.
Take a step back and review business strategy
The first step in developing and implementing a strategy to survive difficult times is to take a step back. Be sure to view your current situation with a fresh, objective and open-mind. Some important questions to ask are:
- What is the root of the problem?: Is it low sales? An inability to turn a profit? Mounting debt? Operational struggles? Your cannabis operation is something you’ve built with your own sweat and tears, and like a child, it may be difficult to see (or admit) the flaws. But this is a matter of survival and you need an objective perspective.
- Is this problem temporary or long-term?: Once you’ve identified the root issue, and it is likely cash-flow related, you need to understand whether this is a short- or long-term issue. If you are confident it is a passing phase, small financial and operational adjustments may be enough. But if the problem is endemic, it may be time to consider major shifts.
- What are the ‘low-hanging fruit?’: There are likely to be some fast and easy immediate steps you can take to improve business performance. One of the best ways to identify and implement these changes is to talk to your staff and customers. They will often have some good (and many bad…) ideas about how to improve operations. Survey them and get their input before making any major decisions.
Cannabis Survival Strategy #1: Lower operating costs
This is an obvious solution but must be addressed at the outset. At its root, profitability is a simple equation of money coming in minus money coming out. The first step is making sure you have clear visibility into this situation. Are you producing financial statements that clearly demonstrate cash inflows and outflows? If not, you’ll need to implement this as soon as possible, or you’re working in the dark.
Once you’ve got reliable Profit and Losses statements, Chart of Accounts, and general ledger, you can identify the areas dragging down performance. Common issues and solutions include the following:
Real estate costs
A major line item for most businesses is real estate costs. In cannabis, this can be a major pain point as gaining and holding property is often an up-hill battle. With changes to operating environments due to COVID-19 you may be carrying more space than you need. Review your office space and any locations to see if you need them, and if not, explore ways you can dispose or optimize them. Selling unused parcels of land can provide a quick capital infusion, and there may be opportunities for sale/leaseback agreements. It may also be possible to rent out unused office, cultivation, or manufacturing space, delivering a new revenue stream without losing access/ownership of the space in the long run.
If sales are down, it is likely you’ll need to adjust staffing for retail locations and/or trimmers and other skilled workers. It is relatively easy to conduct a sales analysis to identify slow times or days. Roll back staffing on these days and you’ll see a big decrease in operating costs. There may also be opportunities to outsource certain functions rather than pay full-time employees. Things like marketing and accounting can be outsourced cost-efficiently.
Some simple cost-saving measures may help decrease costs related to electricity, water, and gas bills. If you’re operating a light deprivation cultivation operation there are likely many strategies you can employ to limit or optimize light usage.
The value of marketing must be tied directly to return on investment. You may think it is necessary to advertise on the major maps and other channels available. However, if you’re not seeing return you’re just wasting money. Take a hard view at your marketing budget and outlays to identify possible cost savings. You don’t want to kill your marketing, but if its not paying for itself, it may not be worth it.
These are just a few common examples of “low-hanging fruit” that can help immediately lower your operating costs and boost your bottom line.
Cannabis Survival Strategy #2: Take a proactive approach to cannabis tax planning
As we all know all too well, cannabis taxes are one of the biggest burdens cannabis operators must navigate. Despite knowing this, all too many cannabis operators do not take a proactive approach to tax planning. And with that, they are potentially losing tens of thousands of dollars each year. To truly optimize your tax approach, you need to be thinking and planning for tax compliance year-round, not just when tax season looms. With a proper tax strategy you can get and pay tax estimates ahead of time. This way, you’re not hit with surprising tax bills. And you can properly allocate Cost of Goods Sold (COGS) to lower your tax bill at year end.
This takes some time and effort to implement, but the cost-savings are truly impactful. It is recommended you consult with a cannabis-focused tax professional to implement and execute this properly.
Cannabis Survival Strategy #3: Diversify cannabis operations
This is another long-term solution to surviving the cannabis industry. The benefits of vertical integration are many. By owning more of your own supply chain you gain many cost efficiencies that can lower overhead and operating costs. Additionally, adding new verticals will bring in new revenue streams that will help your company weather difficult market conditions. And finally, diversifying your operational structure also opens up opportunities for tax savings. For example, business deduction rules for 280E are much friendlier to cultivators and manufacturers than to retailers. Developing a manufacturing operation may allow you to allocate and deduct costs, improving your tax position.
Implementing this strategy is very contingent on local regulations, licensing requirements, and access to capital. The simple fact is, we often find operators not fully utilizing the licenses or capabilities they already have. For example, in helping turnaround a vertically integrated client in California, we discovered they weren’t using their manufacturing license. We help develop a processing facility that ultimately accounted for over 30% of their annual revenue. Sometimes the answer is right under your nose and you just need the guidance to maximize it.
Cannabis Survival Strategy #4: Alter harvest schedules
One of the most common issues we are seeing in the market today is a decline in flower prices in well established markets, like California, Colorado, Oklahoma and Oregon. When the market is inundated with product, cultivators find themselves in a major bind, spending considerably to do what they do, grow great cannabis, but without a ready market to sell into.
With the profusion of indoor and light dep operations, we are no longer tied to seasonal harvest schedules. If you’re an indoor grower, it may be smart to roll back operations in the fall, knowing the outdoor harvest is going to flood the market with product. Since you can control the number and timing of harvests, you may want to scale back operations during certain seasons, and up operations in others. This way you’re limiting overhead and operational costs when there is no ready market for product, while maximizing harvests during optimal times of the year.
Cannabis Survival Strategy #5: Negotiate with debtors
If mounting debts are killing your bottom line, it is best to take a proactive approach with your debtors (and definitely not ignore them!). All businesses understand that SOME money is better than NONE, so if you’re at risk of defaulting on any loans or debts, reach out and negotiate with those debtors. If they are also in the cannabis industry, you’re likely to find an understanding person that is navigating the same issues. You can often work out much better terms that can save your business in the near and long-term.
The same principles apply to tax and regulatory authorities. If you’re behind on tax payments, it is best to work with the tax agency to establish a payment plan. You’ll often find they are open to working with you. One benefit of working with a cannabis-focused accountant is they’ll have the knowledge and relationship to negotiate with tax regulators on your behalf, and may even be able to correct their mistakes. The worst thing you can do is ignore these debts, as interest and fees will pile up quickly and dig a hole you may not be able to escape.
Cannabis Survival Strategy #6: Bite the bullet and sell sell sell
We’re not talking about selling your business! That’s a last ditch effort. We mean taking a cold, hard look at the stock you have on hand and finding the best way to move it. Even if that means taking a loss. Think of it this way, if you’ve invested $10k into product you were planning to sell for $20k, as long as it is on your shelves you’re $10k in the hole. If you offer a big discount to move the product, you may only earn $7k back, but $3k in the red is better than $10K in the red. This simple math scales up and down with the size of your operation. Simply enough, do what you gotta do to move product. A big sale will provide an immediate capital infusion you can reinvest wisely in paying down debts or buying better products.
Naturally, this is all dependent on an effective inventory management system, which we have detailed recently.
Navigating the ups and downs of the cannabis industry has been a surprise to just about every operator in every market and vertical. We all know the good times are coming, but only the strong will survive the downturns like what we are experiencing in many markets today. The most important key is not to get desperate or feel helpless. There are many things you can do to turn things around, and there are also experts available to provide new perspectives. In the worst case scenario, undertaking the strategies listed above will improve operations and financials in the event of a sale, helping secure a strong exit. The worst thing you can do is throw up your hands and give up. Then you’ll lose everything you’ve worked so hard for.
If you’re looking for guidance on optimal operational or financial strategies, or you’d like to get a headstart on tax planning, the cannabis industry experts at GreenGrowth CPAs are here to help. Please schedule a free consultation and we’ll brainstorm ideas that will get you on the right path to long-term success. Reach out to us here or call 1-800-674-9050.