Under most States cannabis licensing requirements, thorough financial accounting and record keeping is part of State Law. A number of states have very high penalties for not keeping accurate books and financials. Under IRS codes sections 280E and 471, accrual accounting (as opposed to cash accounting) is required to maximize allowable allocations of certain costs into Cost of Goods Sold (“COGS”) and Inventory. See more information on 280e here: http://thecannabisindustry.org/federal-policy/
Below is an example of state accounting requirements (Oregon guidelines):
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
Additionally, financial institutions that are allowing banking in this industry are also requiring detailed quarterly financial statements and support.
Produces accurate, timely, and complete financial statements, which include absorption cost accounting
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)
Effective dashboard and key performance indicators
Timely cash and tax forecasting system
Experienced 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 consideration that is indicative of 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.
It is well known that cannabis related businesses 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 date. This means that you will have fewer worries (ie. Can sleep peacefully at night) if you have followed the 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 large amounts of time and effort and can result in sizable fines or worse. Trying to get the documents and items they request 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).
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, often times will be audited, and at the very least extensive due diligence. If you have very detailed, accurate and complete financial records and systems, this will be straight forward and you can maximize the value obtained. However, when incomplete or inaccurate items are uncovered, the valuation will start to diminish. The more “issues and problems” that are uncovered, the steeper the discounts will be on final company valuation.
The first step is to find a high quality outsourced CFO that will join your team on a part time basis. Hopefully he/she has a CPA designation and many years of experience working with and for startups of all types and sizes, from startup to exit. You might think you can’t afford a CFO. Actually a part-time CFO who oversees an accounting staff or a bookkeeper, will cost much less than a full time Controller or Accounting Supervisor, and will add much more value to the business.