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Financial Forecasting for Cannabis Businesses

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June 08, 2020

All cannabis businesses should have a financial forecast.

If it’s the first year of operation and you’re applying for licensing or funding, then you’re going to need a financial forecast. If it’s your second, third or even your tenth year in operation, you will still need a financial forecast to see how you plan to grow over prior year performance.

A recent CB Insights report came out regarding why startups fail and it said 29% fail because they ran out of cash.  There are many reasons to why that happens, but not having a financial plan or forecast is surely a contributing factor.

Without a financial forecast, you’re running your cannabis business without a plan. It’s similar to embarking on a voyage with no map. 

Benefits of Forecasting

Have an operations budget to benchmark your performance against

It is very important to create an operating budget for the year.  It helps you to track your progress month to month and know how your business is performing compared to plan.

An operating budget also helps you understand what costs are higher or lower, and even which sales are higher or lower.  Having this information and the measured delta, you can then take corrective measures if necessary.

Lastly, comparing actual performance to forecasted performance will help you better refine your financial forecast model for subsequent years.

Ability to better control of cash flow

When you create a forecast, you can then determine future cash requirements. 

You know your projected expenses for each period, so you know how much cash to keep on hand to at least cover the bills.  

Let’s explore a quick, back of the envelope calculation on minimum net operating capital on-hand.

The amount of cash on hand will vary depending on your risk tolerance, but you should have somewhere between 2-6 months of your overhead expenses

So once you have your forecasted financials, you can calculate your monthly burn rate, multiply by number of months correlated to your risk tolerance.

It’s important to have cash on hand if something goes wrong, which it always seems to, no matter what business you’re in.

You need to be able to save yourself when you make a mistake or when the market conditions run wild. 

Help you prepare for large revenue and price fluctuations 

You do not want to operate blindly and delude yourself into thinking that every month will be as great as your best months.  It can lead to bad behavior and even the ultimate demise of your business.

As we will get into in the next section, there are many factors that can impact your financial forecast and what you may notice is that some months are higher than others, which can make it hard to manage your operating capital.  

This is especially true if you had NO CLUE that this was going to happen.  So it’s better to know than be unaware that you’re having your best months and not save for later.

Factors such as seasonality and raw supply will likely have major impacts on your financials, so let’s explore those factors and more.

Factors to that impact your financial forecasting

Many of these factors are unpredictable but need to be tracked to see how they impact your business depending on the granularity of your analysis.  Note, this is not a full list of factors, but these are some of the basics that you need to build into your financial forecast if you want to have a solid operating budget to benchmark against.

Seasonality

Raw materials costs will change over time.  This is important for retailers to keep in mind and keep an eye on input costs so you can preserve your margins as prices increase.

This is important for cultivators to understand as well.  When there is a huge boom of supply in October when everyone is harvesting their outdoor crops, you may a dip in prices overall, and especially in the outdoor flower market. This could translate over to lower prices for oil or other derivative products.  Planning your crops out around typical supply changes is critical as well

Demand for product may change over time or specific products in your line such as gift boxes, so pay attention to what you're producing and the timeline associate with it.

Tourism

This builds on seasonality.  As a retailer or vertically integrated business, if you are located in or on the way to a seasonal tourist destination such as a lake or the beach, then you will typically see an uptick in revenue during the warmer months.

It’s important to know this because if you stack up all of your cash during those months, then you can make it through the thinner months, depending on how thin they are.

Weather & Climate

As you know, the weather is finicky and the meteorologist seems to never get it right.

But take note of the ‘relative’ weather in your area.  An example in Los Angeles is that when it rains, larger food chains without delivery see a 3-10% dip in sales during those days. People in LA are not used to running out in the rain and will either pass on getting their product or look for a delivery option.

As for climate, which is more macro, how does average ticket price move when it is winter compared to summer.  You may see that it increases by 15-20% during colder months.

Natural disasters & Pandemics

You can never fully prepare for a natural disaster or a pandemic, but it is important to see how they affect your business.

For example, we know there is a wild-fire season in California which could impact outdoor grows by burning down supply, but also it could knock out power for indoor grows.  This means that you should have a bit more in your safety fund around those times if you need to take desperate measures to save the business.

Another example, with the pandemic, there was an increase in retail sales and even the average ticket price was up.

People going into a lockdown that didn’t want to leave their house, they stocked up on what they deemed to be essential.  How will this be affected with wave 2 or wave 3 of the virus and the corresponding lockdowns?

Day of week

This factor is something you look at in a more granular forecast, such as fluctuations in daily sales and not monthly sales, but it is still important to consider. 

Depending on where your business is located, you may have huge swings in the level of traffic that you see at your retail store.

For example, if you operate in a central business district or near one, then you will typically see higher traffic Monday-Friday and less on the weekends.

Marketing efforts

When you launch a marketing campaign, you expect and hope that this will drive more revenue.  If it’s your first time with this type of campaign, you’re likely guessing about the impact.  

Once you launch your campaign, track sales to a relatively small granularity to see how it impacts your sales.

For example, if you do a coupon in the local street newspaper and it releases on Tuesdays, then see how sales are affected each day after the campaign until the coupon expires. You will see some type of curve and that can help you plan out your inventory when launching a similar campaign later down the road and deploy labor properly.

Now if you plan on running four campaigns this year, you can plot them out onto your forecast to predict bumps in sales and corresponding expenses.

Increase in taxes

Keeping an eye on what the state and local tax authorities are proposing is critical to your financial forecast for two reasons.

First, in most cases, when there is a rise in consumer taxes on cannabis, there may be a subset of people who choose to visit unlicensed shops if they are available in that market.  This happens in California since there are many unlicensed shops.  But for states like Arizona or Michigan, that’s probably not the case.  

You may see people go to local growers for direct access to product, but this surely depends on the consumer’s level of comfortability with that type of situation.

Second, when you see an increase in taxes, this means you need to be more careful with your minimum cash-on-hand requirements.

Tax money is NOT your operating capital.  It should be split out right away from your revenue and put into a separate safe or separate account so that you don’t dip into the money and not be able to cover your tax bill.

When you run into a tax problem, they can become exacerbated very quickly.

Industry growth rate

Every industry is going to feel some type of natural growth or decay in the revenue.  

In the case of cannabis, it gets more popular every day, so in your financial forecast, you will likely see some type of natural growth.

But the nuance to understand is are you maintaining your market share and that’s a hard question to answer because there is not a ton of public data out there on this.

How to improve your financial forecasting

Model out multiple scenarios

It’s easy to feel optimistic when you start to forecast your business performance.  And it’s also easy to be extremely conservative as to not get your hopes up too high, then come crashing down when you don’t hit projections.  We call this sandbagging your numbers.

To be honest, neither is the wrong way to forecast, but you should model out at least two scenarios, one optimistic and another a bit more cautious. 

This is especially true if there is uncertainty surrounding major factors that could impact your business, such as government regulations (yup that’s cannabis), new competition or licenses, or even overall economic growth.

As the year plays out, you can then see where you land on your spectrum of financial performance and create more accurate forecasts for the balance of the year.

Start with expenses

In most cases, expenses are easier to predict than revenues.

You will start with fixed expenses such as rent, insurance, licensing, etc…

Then work on variable expenses such as utilities, CoGS, etc…

To make this the most accurate as possible, you will need to have a relatively detailed cost breakdown of product costs.  Knowing your true cost/lb or your cost/g of oil.  Now if you’re a retailer, you need to know inventory costs and salaries/wages.

The corollary to this is how do these variable costs relate to revenue?  This will help you determine topline revenue numbers for your forecast.

For example, if you purchase $50,000 in product per month, how much revenue can that generate?  How many people will need to be employed to handle that type of transaction volume?

You will jump back and forth between expenses and revenue, and add in additional factors, but you typically start with what you know (fixed expenses), and then dive into creating a methodology to predict the rest.  

An example of this is knowing your rent amount and size of your grow space, you can predict how many grams/sqft you can produce and the revenue that will be generated for the entire space.  When you get those numbers, you can ask, is this a viable forecast, or what needs to change to make this a positive ROI.

Find comparable businesses

To assess the accuracy of your financial forecast, you should compare your projections with other businesses in your industry. 

With cannabis since most companies are private, you will find that difficult, and that’s where you can leverage GreenGrowth CPAs experience by comparing your forecast to our bench of clients.

Constantly reevaluate your model

Your financial models should not be static.

You will see what growth rates are, how marketing campaigns impacted the business, what true product cost inputs are, and that gives you clarity on actual performance.  

Further, input assumptions, expense percentages, revenue, and many other internal and external factors settle as the fiscal year progresses so it’s less guessing and more truing up your model.  Essentially improving your guidance for the year.

Look at the past performance, make changes in your model to reflect this new, more accurate information. 

By having better guidance in your financials, this helps with making smarter strategic decisions for your cannabis business.

If you need help with financial forecasting for your cannabis business, then please reach out to us today.

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Post Tags: Finance, Operations, Accounting

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