Top 5 Accounting Tips for Cannabis Construction Projects: Best Practices to Ensure Financial Success

Jul 18

Effective financial management during cannabis construction projects is crucial for safeguarding both your and your investors' money and assets. Implementing best practices in cannabis accounting, budgeting, timing, contingency planning, and documentation ensures efficient use of funds and protects your valuable cannabis license from regulatory issues.

Furthermore, detailed tracking of construction costs can lead to significant tax benefits through accelerated depreciation, if Section 280E is repealed. In this post, we’ll explore the top five accounting tips to help you navigate the complexities of cannabis construction, ensuring your project’s financial health and compliance. Learn how expert cannabis CPA guidance can optimize your financial strategies and maximize your tax advantages.

1) Implement a Competitive Bid Process

A competitive bid process involves soliciting and evaluating bids from multiple contractors or suppliers to complete a specific project or provide certain services. This method ensures a transparent and fair selection process based on predefined criteria such as cost, experience, and quality of service.

Why Implement a Competitive Bid Process?

1. Cost Efficiency

Reason: By comparing multiple bids, you can identify the most cost-effective option, ensuring that you get the best value for your money. This can significantly reduce the overall cost of your construction project, freeing up resources for other critical areas.
Benefit: This can significantly reduce the overall cost of your construction project, freeing up resources for other critical areas.

2. Quality Assurance

Reason: Evaluating bids allows you to assess the qualifications and track records of different contractors.
Benefit: This ensures you select a provider who meets your quality standards, leading to better project outcomes.

3. Risk Mitigation

Reason: A competitive bid process reduces the risk of overspending and helps avoid the pitfalls of choosing a single contractor without comparing alternatives.
Benefit: It ensures that you are not overpaying for services and materials, protecting your investment.

4. Transparency and Accountability

Reason: A well-documented bid process increases transparency and accountability, as all bids are evaluated based on the same criteria.
Benefit: This reduces the potential for favoritism or corruption, ensuring a fair selection process.

How to Implement a Competitive Bid Process

1. Define Project Scope and Requirements

What: Clearly outline the scope of work, project specifications, timelines, and any other requirements.
How: Develop a comprehensive project brief that includes all necessary details and distribute it to potential bidders.
Benefit: Ensures all contractors understand the project details and can provide accurate bids.

2. Develop Evaluation Criteria

What: Establish the criteria that will be used to evaluate the bids.
How: Criteria may include cost, experience, past performance, timeline, and quality of materials. Create a scoring system to quantify each criterion.
Benefit: Ensures that all bids are assessed fairly and objectively.

3. Solicit Bids

What: Invite qualified contractors and suppliers to submit their bids.
How: Advertise the bid opportunity through industry networks, trade publications, and online platforms.
Benefit: Encourages competition and provides a range of options to choose from.

4. Evaluate Bids

What: Review and compare the submitted bids based on your predefined criteria.
How: Assemble a bid evaluation team to review each submission. Use the scoring system to objectively compare bids and document the evaluation process.
Benefit: Helps identify the best contractor for the project.

5. Select the Contractor

What: Choose the contractor that best meets your project needs and budget.
How: Notify the winning bidder and formalize the agreement with a contract. Ensure that all terms and conditions are clearly outlined and agreed upon.
Benefit: Ensures a clear understanding of expectations and responsibilities, contributing to project success.

6. Monitor and Review

What: Continuously monitor the contractor's performance throughout the project.
How: Conduct regular progress reviews, maintain open communication with the contractor, and adjust plans as necessary.
Benefit: Ensures the project stays on track and any issues are addressed promptly.

2. Maintain Detailed Construction Invoices and an Active Ledger for Loan and Equity Contributions

Maintaining detailed invoices and an active ledger for loan and equity contributions is crucial for optimizing financial transparency and tax benefits in your cannabis construction project. This practice ensures accurate expense tracking and allows for significant tax savings, particularly through accelerated depreciation.

Why Maintain Detailed Construction Invoices and an Active Ledger?

1. Accelerated Depreciation

Reason: Detailed invoices allow you to categorize improvements as 5, 7, 15, and 39-year assets for depreciation purposes.

Benefit: If Section 280E is repealed, detailed records will enable you to claim accelerated depreciation, significantly reducing your taxable income. Proper categorization ensures compliance and maximizes depreciation benefits.

Example for Retail: Consider a dispensary that spends $50,000 on cabinets for material and assembly. If the invoices are detailed, these costs can potentially be deducted in full. In contrast, a vague invoice labeled "build out" lacks the specificity needed for accelerated depreciation.
Example for Cultivation/Manufacturing: For an HVAC system, a single line item for "HVAC installation" does not assist in maximizing tax benefits. However, breaking it down into "rough-in," "fixtures," and "final install" can enable significant savings through accelerated depreciation. Thousands of dollars can be depreciated sooner, reducing taxable income and improving cash flow.

2. Financial Clarity

Reason: Keeping an active ledger for all loan and equity contributions provides a clear picture of who is owed what, calculating interest, and establishing inside/outside basis.

Benefit: This practice ensures accurate tracking of financial contributions and obligations, simplifies interest calculations, and provides clear documentation for financial audits and tax preparation.

Example: Detailed loan documents that accrue interest payable and track equity balances, especially if they are convertible, ensure transparency and accurate financial reporting. This clarity helps in making informed financial decisions and managing investor relations effectively.

How to Maintain Detailed Invoices and an Active Ledger

1. Categorize Expenses

What: Record all construction-related expenses in detail, categorizing them by asset type and lifespan (e.g., 5, 7, 15, 39 years).
How: Use accounting software to categorize expenses accurately. Ensure each invoice includes specific details about the nature of the expense and its classification.
Benefit: Enables precise tracking and proper categorization for depreciation purposes, optimizing tax benefits.

2. Track Loan and Equity Contributions

What: Maintain a comprehensive ledger that details all loan and equity contributions.
How: Update the ledger regularly to include new contributions, repayments, interest calculations, and any changes in ownership or financial obligations.
Benefit: Provides a clear and up-to-date record of financial contributions, simplifying financial management and ensuring transparency.

3. Document Everything

What: Keep meticulous records of all financial transactions related to the construction project.
How: Store invoices, contracts, and payment receipts in an organized manner, either digitally or physically.
Benefit: Ensures that all financial documentation is readily available for audits, tax filings, and financial reviews, reducing the risk of discrepancies and compliance issues.

3. Document Lien Waivers and Inspections

Ensuring that cannabis construction projects are protected involves meticulous documentation of lien waivers and inspections from municipal and state cannabis control divisions. This practice safeguards investments and ensures regulatory compliance, which is crucial for obtaining and maintaining your cannabis license.

Why Document Lien Waivers and Inspections?

1. Protect Investments with Lien Waivers

Reason: Lien waivers ensure that contractors and suppliers have been paid in full for their work, releasing the business from any future liability for unpaid work claims.

Benefit: Paying licensed contractors only after the job is complete and the lien waiver is signed protects your investment by preventing contractors from placing a lien on your property for unpaid work. This legal safeguard ensures that once the waiver is signed, the contractor cannot claim additional payment or place a lien on your business assets.

2. Ensure Work Quality and Compliance with Inspections

Reason: Inspections from the municipality and state cannabis control divisions confirm that the construction work meets all regulatory standards and codes.

Benefit: Documenting inspections ensures that the work performed is up to par, which is critical for obtaining and maintaining your cannabis license. Regular inspections prevent costly rework and ensure that your project adheres to legal and safety standards, ultimately protecting your license and business operations.

How to Document Lien Waivers and Inspections

1. Obtain and Store Lien Waivers

What: Secure lien waivers from contractors and suppliers upon completion of their work.
How: Ensure that all contractors sign a lien waiver before issuing final payment. Store these documents in an organized manner, either digitally or physically.
Benefit: Protects against future claims for unpaid work, ensuring that all payments are accounted for and documented.

2. Schedule and Document Inspections

What: Arrange for regular inspections from municipal authorities and state cannabis control divisions throughout the construction process.
How: Schedule inspections at key project milestones and document the results. Keep records of all inspection reports, corrections, and approvals.
Benefit: Ensures that construction meets all regulatory requirements and standards, which is essential for licensing and operational compliance.

3. Pay Licensed Contractors Post-Inspection and Lien Waiver

What: Make final payments to contractors only after the work is inspected and lien waivers are signed.
How: Implement a payment protocol where final payments are contingent upon completed inspections and signed lien waivers.
Benefit: Protects your business from legal liabilities and ensures that all work is completed to satisfaction before final payment is made.

4. Create an Itemized Budget with a Timeline

Creating an itemized budget with a timeline for each line item is essential for managing your cannabis construction project effectively. This practice allows you to track expenses, manage cash flow, and make informed financial decisions throughout the project.

Why Create an Itemized Budget with a Timeline?

1. Track Over/Under Budget

Reason: An itemized budget helps you know exactly where the project stands financially for each line item.

Benefit: By tracking over/under budget status for each item, you can identify areas where costs are exceeding expectations and make adjustments accordingly. This level of detail helps prevent budget overruns and ensures that funds are allocated efficiently.

2. Cash Management

Reason: A detailed budget is crucial for effective cash management.

Benefit: Understanding the financial requirements of each phase of the project allows you to ensure that you have enough cash on hand to cover ongoing expenses. This is especially important for projects that have irregular cash flows, such as construction, where large payments may be due at specific milestones.

3. Raising Capital

Reason: Detailed budgeting is essential for attracting investors and securing financing.

Benefit: An itemized budget provides potential investors with a clear picture of how their funds will be used and the financial health of the project. It demonstrates fiscal responsibility and increases investor confidence, making it easier to raise capital.

4. Rent/Mortgage Allocation

Reason: Keeping track of the timeline helps you anticipate additional months of rent or mortgage payments during non-revenue periods.

Benefit: Allocating these costs in your cash flow analysis ensures that you are prepared for the financial burden of extended construction timelines. This foresight prevents cash shortages and ensures that you can meet all financial obligations even if the project takes longer than expected.

How to Create an Itemized Budget with a Timeline

1. Identify All Cost Items

What: List all potential expenses associated with the construction project, including materials, labor, permits, and contingencies.
How: Break down each major category into specific line items. For example, instead of a single "construction" expense, include line items for framing, electrical, plumbing, HVAC, etc.
Benefit: Provides a comprehensive view of all expenses, ensuring no costs are overlooked.

2. Assign Costs to Each Item

What: Estimate the cost for each line item based on quotes from contractors, historical data, and market rates.
How: Gather detailed quotes from multiple suppliers and contractors to get accurate estimates. Use these quotes to populate your budget.
Benefit: Ensures that your budget is based on realistic cost estimates, reducing the risk of underfunding.

3. Develop a Project Timeline

What: Create a timeline that outlines the start and end dates for each line item or project phase.
How: Work with your project manager and contractors to develop a realistic timeline. Use project management software to track progress and update timelines as needed.
Benefit: Helps you anticipate cash flow needs and schedule payments appropriately.

4. Monitor and Update the Budget Regularly

What: Continuously update the budget and timeline as the project progresses.
How: Hold regular budget review meetings with your project team to discuss progress, identify any deviations from the plan, and make necessary adjustments.
Benefit: Keeps the project on track financially and allows for timely interventions if issues arise.

5. Incorporate Rent/Mortgage Costs into Cash Flow Analysis

What: Factor in the cost of rent or mortgage payments during the construction period into your overall cash flow analysis.
How: Include these costs as separate line items in your budget and adjust them based on the expected construction timeline.
Benefit: Ensures you have a realistic view of your cash flow needs and can plan accordingly to cover all expenses.

5. Allocate Contingency Funds for Change Orders

Allocating contingency funds for change orders is a crucial practice for managing cannabis construction projects, especially given the complexity and scale of such endeavors. This ensures that you are prepared for unforeseen changes that can impact both the budget and timeline.

Why Allocate Contingency Funds for Change Orders?

1. Financial Preparedness

Reason: The larger and more complex the project, the higher the likelihood of encountering change orders. These can arise from unforeseen issues such as structural problems, design changes, or regulatory requirements.

Benefit: Allocating contingency funds ensures you have the financial resources to cover unexpected costs without disrupting the project’s cash flow. This preparation helps prevent budget overruns and financial strain.

2. Timeline Management

Reason: Change orders can also impact the project timeline, potentially extending the completion date and increasing costs associated with delays, such as additional rent or mortgage payments.

Benefit: By accounting for potential delays and updating your budget and timeline accordingly, you can manage cash flow more effectively and ensure that all expenses are anticipated and covered.

How to Allocate Contingency Funds for Change Orders

1. Reserve Additional Funds for Each Line Item

What: Set aside approximately 10% of the budget for each line item as contingency funds, unless materials already have a purchase order or letter of intent, or the labor involves straightforward tasks such as installing fixtures.
How: Incorporate this contingency into your initial budget planning. For instance, if the estimated cost for electrical work is $50,000, allocate an additional $5,000 as a contingency fund.
Benefit: Provides a financial buffer to cover unexpected costs, ensuring the project can proceed without significant financial disruptions.

2. Identify Vulnerable Line Items

What: Pay particular attention to line items that are more susceptible to large change orders, such as those involving structural changes, electrical, plumbing, or HVAC work.
How: Allocate a higher percentage of contingency funds for these vulnerable areas. For example, reserve a 15-20% contingency for projects that involve opening walls or major system changes.
Benefit: Ensures that areas with a higher risk of unexpected costs are adequately covered, preventing budget shortfalls.

3. Update Budget and Timeline Regularly

What: Adjust your budget and timeline to reflect the impact of change orders as they occur.
How: When a change order is issued, immediately update your financial projections and project schedule. Include any additional costs and extended timelines in your cash flow analysis.
Benefit: Keeps your financial plan current and accurate, allowing for better cash management and preventing surprises in the project’s financial and operational execution.

4. Reflect Additional Rent/Mortgage in Cash Flow Analysis

What: Account for any additional rent or mortgage payments that may result from project delays due to change orders.
How: Include these costs in your updated cash flow analysis to ensure you have sufficient funds to cover extended timelines.
Benefit: Ensures you are financially prepared for any delays, maintaining the stability of your cash flow throughout the project.

Conclusion - accounting for cannabis construction

Effective financial management is crucial for the success of cannabis construction projects. Implementing best practices like a competitive bid process, maintaining detailed invoices and ledgers, documenting lien waivers and inspections, creating an itemized budget with a timeline, and allocating contingency funds for change orders can safeguard your investments and ensure project success. These strategies help manage cash flow, ensure compliance, and attract investors, providing a solid foundation for your cannabis business. For personalized advice and tailored financial strategies, contact Greenbooks CPA today to optimize your cannabis construction endeavors.

Tech striker