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Cannabis operators have a lot to keep track of. From staying compliant with complex regulations to tracking KPIs and staying alert for signs of embezzlement, running a cannabis operation involves wearing many hats.
A tool that can make your job easier is a proper chart of accounts. This financial structure provides a strong foundation for managing and tracking your accounts, cash flow, and tax responsibilities easily.
What is a chart of accounts?
A chart of accounts is an index of the financial accounts in the general ledger of an organization. This index shows all the financial transactions completed during a specific accounting period, broken out by five main categories: assets, liabilities, equity, revenue/income, and expenses.
Under each main category, transactions are further itemized into smaller categories. For instance, under assets, you might list:
- Undeposited funds
- Accounts receivable
- Other equipment
Accounting tools like Quickbooks and Xero don’t come equipped with a cannabis-specific template preloaded so you will need to work with a CPA that has industry experience to get a cannabis-specific chart of accounts, or reach out to our team.
A chart of accounts (COA) is helpful for organizing your finances, adding accountability internally, and giving investors, auditors, and shareholders clear insight into your business’s financial health. A COA is vital to meeting the strict and complicated reporting standards of the cannabis industry. It makes it much easier to prepare quarterly financial reports, as well as your tax returns.
Chart of Accounts for cannabis businesses
On principle, a company’s financial statements can be no more detailed than the underlying chart of accounts structure.
For a cannabis operator, the COA is even more important than for other businesses. As you may know, 280E limits you to only deduct CoGS from your revenue on your tax return; therefore, you need to classify expenses properly to make the most out of your limited deductions.
A specific COA for your cannabis operation will help you when it comes time to prepare your taxes. The cleaner your books, and the more detail you provide about each transaction, the easier a time your accountant will have in making the most thoughtful allocation for CoGS on your taxes.
The more you can classify expenses on your own, the cheaper your tax prep will be. Accountants aren’t cheap investments: if you can help reduce the amount of time they need to spend cleaning up your books, the more money you will save. Likewise, a COA helps you avoid gross negligence from the IRS or from your investors.
A clean chart of accounts will pay big dividends in the future because it helps limit difficulty in providing tax information, audit support, or financial statements.
Further, a well-thought-out cannabis chart of accounts can generate better, more accurate reporting on your cannabis business performance and the drivers of financial performance. For instance, a COA gives you a better picture of your deductible vs. non-deductible costs, allowing you to spot opportunities to move non-deductible into deductible and save on your taxes.
How to build a chart of accounts
Because most tools don’t allow you to build a cannabis-specific COA, you may have to do most of the heavy lifting yourself. Here’s how to get started:
Structure your COA for management; not for GAAP or tax purposes. Set up your COA to help your financial managers. As one expert recommends, “create financial reports with the information you want to see. Tax and audit CPAs adjust your reports to fit their purposes anyway, so go ahead and make a complete break. The new goal is financial reports that provide the metrics you need to run your operation throughout the year.”
Define gross margin correctly. Gross margin is defined as profit after direct costs. Direct costs can be defined differently depending on your business. A good general rule of thumb is to make sure your direct costs on your managerial financial statements are the same as costs you use for quoting or pricing calculations.
Define your indirect costs. An indirect cost is an overhead expense that relates to your sales, yet cannot be traced to a specific product. Some indirect costs can be listed as COGS, so pay particular attention to this category.
Organize operating expenses to match the budgeting level of detail. Your COA should match the categories of accounts and expenses that your cannabis company is required to report. It’s also helpful to learn from the management team how they want to treat certain expenses. For instance, is a technology subscription part of marketing or part of finance? Or do those expenses get categorized in a separate category altogether?
Use account numbers. “Best practice is to use the 10000s for asset accounts, 20000s for liabilities, 29000s for equity, 30000s for sales, 40000s-50000s for direct/indirect costs, 60000-70000s for operating/overhead expenses, and 80000-90000s for non-operations accounts such as interest and taxes.”
Work with your accounting team and your CPA to find a COA that works best for your unique business. The goal is to make the COA as clear, functional, and user-friendly as possible.
Tips on cannabis-specific Chart of Accounts
Part of making your COA useful is to have one that’s detailed, but doesn’t get too deep into the weeds. For instance, there is no need for separate office pens, office paper, and paper clips accounts: a simple ‘office supplies’ account will do. With wages, however, you should break them down into separate accounts by job title and/or position, especially in a cultivation business or manufacturing. This breakdown helps when you go to back specific types of wages into CoGS.
Here’s an example of what an account breakdown might look like for a cannabis cultivation business:
- Grow Contractors
- Grower Wages
- Payroll Taxes - Growers
- Trimmer Wages
- Payroll Taxes - Trimmers
- Packaging Wages
- Payroll Taxes - Packaging
- Sales Wages
- Payroll Taxes - Sales
Your COA is a living document: you should revisit it annually with your CPA. Businesses evolve, and maybe when you first started out, you were only doing cultivation or retail and then added a different vertical into your business such as manufacturing. Opening this new vertical may actually have exposed you to some more tax benefits.
With the proper accounting, and a reasonable methodology to allocate costs into the right accounts, you can save money. To build on that, see which accounts have ballooned in size to see if they can be broken down even further, and see if there are any other accounts that should be added because of your new line of business that could open up tax advantages for your operation.
If you need help with your cannabis business chart of accounts or cannabis accounting, then please reach out to our team today.