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Best Practices for Managing Your Cash on Hand

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October 18, 2019

The 280E regulation requires cannabis operators to deal with an inordinate amount of cash. The term “cash flow” takes on new meaning for businesses in this cash-heavy industry. Cash is the oxygen of any business, and when you’re just starting out, it’s likely that you may have some cash flow issues. 

One study found that poor management of cash flow is the cause of 82% of all business failures in the US. Early initial expenses like rent, licensing fees, and taxes can sink your cash flow before you’ve even had the chance to generate sales. 

There are ways to mitigate risks to your cash flow by choosing which bills to pay first and building a rainy day fund for when you get into trouble. 

In this post, we’ll discuss how to prioritize your working capital to help you stay out of the red. 

What is cash flow?

Cash flow is a key business metric that describes “the net amount of cash and cash-equivalents being transferred into and out of a business,” according to Investopedia

All businesses face some challenges in regulating their cash flow. In the cannabis industry, however, the production lifecycle of cannabis, as well as taxes and banking regulations, can make it difficult for operators to have enough cash on hand to cover operating expenses. 

Cannabis operators must pay close attention to cash flow: it can mean the difference between staying afloat or slowly sinking into financial ruin. 

In previous posts, we’ve outlined some tips to help you manage your cash flow, including: 

  • Know your inventory restock lifecycle
  • Plan for emergencies
  • Outsource your CFO function
  • Practice good bookkeeping
  • Work with an investor

In addition to these strategies, cannabis operators should prioritize their working capital to meet their financial obligations when cash flow is tight. Here’s how.

How to prioritize your working capital

Let’s examine how a cannabis business should allocate their cash to competing business priorities. When you are paying your bills, here’s what our experts suggest paying first (as applicable) on a monthly basis. 

  1. Taxes: set aside, reserve, and pay cash for taxes collected on the sale of products to the state and local government. You are legally required to pay taxes, which is why this should be your first priority. After sales taxes and from the general operating account, reserve and pay federal or state income taxes for the business. Next, set aside and pay any federal state employment-related taxes for employees.  And lastly, NEVER, for any reason, use tax money to help float your operating capital!
  2. Rent and utilities: the next priority should pay your lease and utilities, as well as any other expenses related to your business’s premises (like insurance). If you can’t keep the doors open and the lights on, it’s unlikely you’ll get out of your cash flow crunch.

  3. Other business expenses: vendor accounts payable, salaries owed to employees, and other selling, general, and administrative expenses must be covered next.

  4. Rainy day fund: more on this in a minute, but a rainy day fund is crucial to building stability into your business.

  5. Reserves and shareholder payments, if applicable. As funds are available and not otherwise needed to meet operating expenses for the company, you may make payments to your investors or shareholders in proportion to their percentage of ownership.

Let’s go a bit deeper into point #4...rainy day funds.  When you have positive cash flow, it’s a good idea to pay a selected percent into a rainy day fund that will be incrementally grown over time.  This fund should eventually be able to cover the operating expenses of your company for up to 60 days. It helps you bridge points in time when there’s not enough cash flow to cover an unexpected expense or to keep you going until your next payment comes through.

Other reasons you might wish to use a rainy day fund? 

If you’re recruiting a new worker, or if someone quits and you need to hire a replacement. Some analysts estimate the cost of hiring the wrong employee can be up to 2.5x the salary – that’s easily over $100,000, depending on the role. Natural disasters like the fires up in Northern California are also one of those unexpected expenses that can throw a wrench in your operations if you’re not prepared. 

Unfortunately, credit isn’t always available for cannabis businesses, unless you are lucky enough to get a private bridge loan. These loans are collateralized against your assets or even non-aged accounts receivables that are in good standing. Generally, a rainy day fund is a good alternative solution that can build confidence in your business. 

Get help managing your cash flow and accounting for your cannabis business by reaching out to us or clicking the button below. 

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Post Tags: Finance, Accounting

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