A Complete Guide to Cannabis Inventory Valuation and Costing Methods

cannabis_inventory_valuation_costing

In today’s dynamic cannabis industry, it’s vital for dispensary owners and retailers to have an efficient POS software system that features suitable costing methods for proper inventory valuation and management. Understanding inventory valuation and its importance will not only help you implement a compliant inventory system but also help you optimize your cost of goods sold, thus boosting your business’ bottom line and pivoting it towards success.

What is ‘inventory valuation’?

For a cannabis dispensary or store, we may classify inventory into the following categories:

  • Primary– Products sold in the same form as purchased: marijuana buds, seeds or flowers are sold by weight.
  • Secondary– Products prepared in-house: pre-rolled joints, concentrates and edibles.
  • Tertiary– Anything that helps in administering medicinal or recreational cannabis: Lighter, rolling paper, THC extraction equipment, etc.

Inventory valuation is an accounting method that refers to the total cost value of all these products in stock at any given point in time during the company’s accounting period.

Why is it important to calculate inventory value?

Assigning a $ value to all goods in stock is a crucial aspect of cannabis inventory management, as this amount represents a significant portion of your current assets in the financial statements of a business and helps you make better decisions as per available funds. Any inventory that gets sold frees up more cash flow for the company to replenish goods and maintain the required stock.

The sum of the value of all sold inventory and any associated direct costs is equal to the cost of goods sold, and COGS subtracted from total revenue gives us gross margin. Tracking inventory metrics like gross margin will present a clearer assessment of what portion of company revenue is available for other operational costs and keep you focused on strategizing ways to increase it while maximizing profit.

Inventory costing methods for cannabis businesses

There is no one-size-fits-all inventory costing method that works for all establishments, and each business must evaluate and identify a suitable solution. In cloud-based inventory management systems, there are various costing methods to be considered, but in the world of cannabis– where we deal with highly perishable goods, choosing one from the following three methods would be ideal:

  • FIFO METHOD (First-in, First-out)
  • LIFO METHOD (Last-in, First-out)
  • WAC METHOD (Weighted Average Cost)

1. FIFO METHOD

The first-in, first-out method of inventory valuation is favoured by most businesses operating in perishable goods sectors like the food industry. This inventory management technique requires that the goods purchased first must be sold first. Thus, the remaining inventory will consist of your most recently purchased or made goods, which will be accounted for at their purchase cost and correspond to the current value of inventory.

This costing method helps in preserving the freshness of all perishable cannabis goods and reducing waste due to spoilage, while also adhering to state and provincial laws that mandate efficient seed-to-sale tracking and destruction of unsold products after expiry.

In an industry affected by price volatility and the existence of an illicit market, the FIFO accounting method also allows small retailers to report lower COGS and higher gross or net margin by selling older, lower-priced products first and leaving recent higher-priced products in their inventory. However, for higher-volume transactions in scaled-up operations, FIFO can complicate accounting, and it may be better to use a simplified alternate method.

2. LIFO METHOD

The last-in, first-out method is the complete opposite of FIFO that entails the sale of most recently purchased goods first while letting older goods remain in inventory longer, thus increasing storage costs, overall cost of goods sold and spoilage risks.

LIFO can be advantageous if you want to reduce taxes by reporting higher COGS and lower profit margin, or if you have a high inventory turnover, no wastage, and want to avoid higher costs of efficient inventory management.

However, this solution is not recommended for cannabis businesses, primarily because cannabis products are highly perishable and may expire before their sale, resulting in higher wastage and losses.

3. WAC METHOD

The weighted average cost method is the simplest among all inventory costing methods because it calculates the average value of all inventory in stock, regardless of when each item was purchased or would sell. The weighted average cost per unit is equal to the total costs of goods in inventory divided by the total number of units.

This quick and efficient solution is particularly useful in the scenarios of high-volume sales and volatile prices. It also helps in better inventory management when multiple strains or batches of cannabis flowers are mixed to make infused oils or edibles, and it becomes challenging to calculate individual item costs. The seed-to-sale tracking needs to be paid special attention to while using the WAC inventory valuation method.

Streamline your cannabis inventory management and reporting

Inventory valuation and reporting are essential to running a successful cannabis retail business that conforms to all regulations. Not all dispensary POS software systems offer features such as detailed analysis and customized reports. It is crucial to supplement your new business with the right cannabis software solution that meets all requirements, from choosing the most appropriate inventory costing method to auditing and real-time reporting.

Efficient reporting gives you insights on when a product may become out of stock so that you can place an order as per lead times and always have only adequate inventory in stock. Proper reporting also helps in optimizing operations by setting promotions on products that are about to expire and raising prices for the ones that are high in demand. Customized reports let you understand consumer behaviour and profiles better, allowing you to make more informed decisions regarding your marketing and sales strategies.

Cova’s reporting system provides you with all these insights while letting you effectively manage your inventory and run your business from anywhere with detailed reports on your mobile dashboard. To learn more about what Cova can do for you, book a demo with us now.

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