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Analyze and Optimize Cannabis Cultivation Cost Per Pound

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June 18, 2020

The nature of cultivation businesses is that they are loaded with upfront costs with no return on that investment until much later when compared to dispensaries or cannabis manufacturing businesses.

Cultivation sites have expensive build outs of $70-150/square foot and all of the cash that operators need to shell out for growing a crop will only return as revenue IF the crop makes it through the multi-month process AND passes testing.

To build on this, you’re always shelling out more cash to either scale-up the operation or finance a new crop. 

On a cash basis, this looks horrible, especially in the first 18-24 months.  Lots of cash going out, being dumped into CoGS, compared to cash coming in as revenue.

For one grow operation or a smaller scale business, this can be tolerable.

But with multiple grows or larger-scale operations, you will look at your P&L and always be in a loss position.

Now, conversely, when you do your accounting on an accrual basis and you will show a positive profit margin, to the extent that you are positive.

This essentially means you’re not just putting costs directly into CoGS.

You first build up inventory, then flush these costs to CoGS with accrual adjustments as your product is sold, and that’s likely not something your $25/hr bookkeeper knows how to do.  We won’t cover the difference in cash vs accrual accounting, but all you need to know is that the methodologies make your numbers look incredibly different.

But at any rate, this is why you need to know a full and accurate cost per lb to show your margins and finally your profitability, no matter what your accounting method is.

This is especially true when you scale your cannabis cultivation up.

You have to make a choice to put more money into a new grow site or expand the current operation, and you can only make the choice to scale if you have an accurate cost per pound and corresponding margins.

Ways to improve the value of your cannabis cultivation business

Creating/documenting SOPs for a Turn-key operation

Obviously your business doesn’t run itself, there are people behind the curtain pulling strings and making the business move forward.  Now when one of those people leaves or your business gets acquired, you have a huge loss of vital operations information.

So the first thing you need to do is document every position’s daily tasks from master growers, juniors, salespeople, warehouse...everyone!  

There are many excuses out there as to why this is not getting done such as: “You need to just feel the plant” or “You need to see it to make a choice.  Cut the excuses and document things such as schedules, decision trees, and anything else you can teach the next person. 

There are many tools our there for SOP tracking, but in a worst-case scenario, just put it word processing document.

During cannabis M&A transactions, there is always a material discount for undocumented processes, because there is no way to repeat your success without you or the other critical actors within the business.  

You may see this as a bargaining chip, but investors see it as a huge risk to their investment. 

An additional benefit to this is that these trade secrets can then help generate more revenue or reduce loss.

  • First, you can license your cannabis IP (standard operating procedures) out to other growers with JV deals. 
  • Second, they can be used to scale from one grow site to the second, third, etc… as seamlessly and quickly as possible.
  • Lastly, if someone calls out or quits, the business can get back on its feet faster because the jobs have been documented and you can drop a new person right in.

Implement information tracking systems

There is no objective way to measure the financial health and viability of your business if there are no information tracking systems implemented.  

It can seem like a headache or highly unnecessary to implement a robust and granular system at the onset of the business, but it is necessary to assess and prove your profitability.  

It also creates discipline and accountability for workers at every level, all the way up to the owners.

One of the chief benefits of tracking data as early as possible is that you have historical data to see the trajectory of your operation as you optimize.  

As the saying goes, you can only manage what you measure, so measure it all and manage it as necessary. 

The more granular the data, the more insights you can pull from it to make strategic decisions about the business.

A very basic example of this is that if you see wages and salaries bump up 12% from Q1 to Q2, you can dig in to see which roles drove that and if there were any tracking issues or this was to be expected because you were prepping for outdoor grows.  

The systems you need are based around time tracking, financials, and product yield performance.

Knowing True Cost per pound

Very few cultivators know their ‘true’ cost per pound, taking into account all necessary expenses, but think they do.

Most look at consolidated or aggregate financials, divide it by the number of pounds and voila, we’re good to go.  But that only works if you have only one grow area and one strain.  Which is likely not the case for a majority of operators.

The complications of knowing a true cost per pound reveal themselves when you have:

  • Mixed grows (indoor/outdoor)
  • Multiple strains
  • Multiple rooms or grow sites
  • Constant harvesting because costs change over time

Walk-Through of Cost per Pound

Let’s review a high-level walk-through for calculating and this is where systems are incredibly important.  

For every expense the company has, whether it’s nutrients, labor, app subscription, taxes, whatever, it needs to be tracked as granular as possible.  From grow type (indoor/outdoor), which strain, which area/room it was grown in, or if it’s overhead.  The more detail, the better that you can analyze your business which we will talk about in a moment.

You will need to list out all of your expenses:

Direct Expenses

You will allocate these based on the detail of your chart of accounts as described above.  When you buy nutrients, can you tie it to a specific strain, room, or area of your grow?  What about lab tests?

These are expenses that should easily tie back to a specific plant or area of your operation.  When I say easily, that’s only if the expenses are being tracked as they are made.  Going back and cleaning up this information can get quite difficult and messy.

Indirect Expenses

You will need to develop a reasonable methodology for these. 

Payroll costs such as wages, payroll tax, health insurance, bonuses, workers comp, meals, recruiting costs, you can use job codes or project codes to allocate these.  It can be as simple as indoor vs outdoor, or down to the exact step in every grow process.

Overhead costs can be allocated such as:

  • Water & Electric: Add meters to grow rooms/areas
  • Mortgage/rent: based on square footage
  • Insurance: based on square footage

Other overhead costs such as taxes, sales/marketing, accounting/compliance, and other back-office expenses need their own methodologies developed.

Now once you have this expense allocations done, you simply compare these to your number of pounds produced depending on the granularity of your tracking.

Do you want to compare an overall company price per pound of $428/lb or would you like to know that Outdoor costs $319/lb and indoor costs $524/lb. Or would you like to break it down further such that indoor OG is $743/lb, indoor blue dream is $629, and indoor afghan is $561/lb AND has financial records to back it all up.

Presenting Your Cannabis Cultivation Numbers

Importance of Margins

At a quick guess, it is likely cheaper to create outdoor product compared to indoor, but what is the margin, which leads up to discuss the sale price.

For example, if your outdoor flower costs $319/lb and you can sell it for $650, then your profit margin is 51%.

Now for indoor, your cost per lb is $524, and you can sell it for $1,300 all day, then your profit margin is 60%.

Yes, the scale of outdoor may make you more money, but knowing margins allows you to manage and control costs, as well as decide what your next move is.  Also, understanding bumper crops vs prime crops, do they have different margins and do these margins change by month or quarter?

A more impactful example is if you see two indoor crops, one with a margin of 60% and one with a margin of 37%, which one will you allocate more grow space for during the next crop? From a financial perspective, the 60% margin one, and then you take into account all of the other factors such as consumer demand.

As we said before, it always looks like you’re running at a loss or close to zero with cultivation business so being able to show investors, owners and potential buyers of the business your margins helps you to truly show the profitability of your business.

Importance of having historical data to track progress

This cannot be overstated, being able to see lines, not dots is incredibly important.  Stakeholders want to see trends in how costs and revenues are moving in a business.  

This will allow you to start dialing in costs and making your business more profitable.  It will also reveal how much more you can break down the numbers for analysis.  

For example, if you see labor costs are higher MoM, but there are no job codes to peel back, then now you implement job codes so in the future you can see what’s changing and why in your labor.

If you want cannabis to be mainstream and a more attractive investment, then you need to track and analyze these numbers.  Corporate big agriculture does this.  They tell the story behind the numbers and they won’t pay big bucks for your fairy tale numbers.  They want a fact-based documentary. 

If you need help with analyzing your cannabis cultivation business, then please reach out to us today.

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Post Tags: Finance, Accounting

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