Inventory Costing Methods for Dispensaries: FIFO, LIFO, WAC
By Green Bits
Cannabis dispensaries play a vital role in the health and wellbeing of their patients and customers. In many cases, cannabis products address medical problems in ways that no other pharmaceuticals can.
However, medical and recreational dispensaries are businesses and must turn a profit in order to keep their doors open. The financial health of any cannabis dispensary depends on accurately calculating inventory costs, overhead costs, and revenue.
This is also true for non-profit dispensaries operating in states like Arizona, where regulations prohibit the establishment of for-profit medical marijuana businesses. In fact, non-profit disclosure laws make it even more crucial for dispensary owners to report their financial data efficiently and accurately.
But small business inventory management is already difficult and time-consuming. Inventory management in a highly regulated, all-cash industry with products sold by weight (rather than strictly defined units) is even harder to achieve. Today’s cannabis dispensary managers need to implement streamlined solutions for inventory management in order to produce desired results.
Inventory Costing Methods for Cannabis Dispensaries
The economics of inventory management are clear. It is in every dispensary’s best interests to implement an inventory valuation system with three main characteristics in mind:
Efficiency. Every employee-hour spent on inventory management carries an opportunity cost equal to the next-most productive thing that employee could be doing. Dispensaries need to implement inventory solutions that reduce waste and improve cash flow.
Accuracy. In a highly regulated sector like the cannabis industry, inaccurate financial reports can drive an otherwise-thriving business directly into the ground.
Scalability. Automation-friendly inventory management solutions are crucial for dispensary owners who wish to expand their operations.
There is no one-size-fits-all option for calculating inventory costs; a restaurant will need to calculate its inventory in a different manner than a heavy equipment manufacturing firm. Three options stand out in the world of inventory management:
First-in, First-out (FIFO)
Last-in, First-out (LIFO)
Weighted Average Cost (WAC)
1. First-in, First-out (FIFO)
Most restaurants, bars, and other purveyors of perishable goods opt for the first-in, first-out method of inventory valuation. This technique assumes that the goods your dispensary purchases first are the goods it sells first. This means that the remaining inventory consists of your most recent purchases, to be accounted for at their current cost.
The practical benefit of this valuation method is that it preserves the freshness of perishable goods and reduces waste due to spoilage. The majority of restaurants use the FIFO inventory management valuation method for this purpose.
In the cannabis industry, this method is useful because most states require dispensaries to destroy unsold cannabis after a certain time. Specifically, most testing laboratories’ Certificates of Analysis have an expiration date, often six months after the testing date.
FIFO inventory management also protects dispensary owners from price volatility and inflation. Because the dispensary sells older, lower-priced goods first while leaving higher-priced products in inventory, it is able to report lower costs of goods sold and higher overall net income.
The drawback of using FIFO is that there will be a mismatch between today’s revenue and the inventory costs of old products. For relatively low-margin products, this is not a major problem until the company starts moving enormous volume, at which point more sophisticated options (most of which involve hiring an entire accounting department) become available.
The LIFO method is less popular than FIFO, but it can provide certain types of businesses with valuable advantages. It is essentially the opposite of FIFO – it assumes that the most recently purchased goods are sold first. This means that older goods tend to remain in inventory longer, increasing the overall costs of goods sold.
This method ultimately yields lower profit margins and net income, which can serve to reduce tax burdens. However, it is not recommended for cannabis dispensaries as perishable cannabis products may expire before they sell.
LIFO may be an acceptable solution if your dispensary has such a high stock turn that you’re virtually guaranteed to avoid waste due to inefficiency. Even then, expanding the business while maintaining FIFO inventory management is typically a better option.
Companies that sell perishable goods typically don’t use LIFO inventory management. It is more common among businesses that sell homogenous commodities and building materials like stone and bricks.
3. Weighted Average Cost (WAC)
For many businesses, neither FIFO nor LIFO is an ideal inventory management option. The weighted average cost method offers a middle ground between these two methods.
Companies that use this technique calculate the average value of their inventory using the following equation:
WAC = (Total Cost of Current Inventory) ÷ (Number of Units)
This levels the playing field between older goods and newer goods while saving inventory managers’ time when selecting goods to be sold first. It is fast, efficient, and accurate enough to serve the needs of cannabis dispensaries.
WAC calculations are especially useful when it’s impossible to calculate the cost of an individual item or when prices for high-volume goods are volatile. If your dispensary is suffering from price volatility from cultivators, regulatory hurdles, or lab testing bottlenecks, WAC may offer the most accurate way to control fluctuating costs.
Concentrate manufacturing is another area where WAC may improve inventory management in the cannabis industry. If a manufacturer mixes multiple cannabis plant batches to create a large volume of hash oil concentrate and then mixes multiple batches of the same concentrate, accounting for the mixture using a weighted average is likely to produce better results – as long as you remain accountable for your state’s seed-to-sale tracing regulations.
Implement an Efficient Inventory Management System for Your Dispensary
Whether you choose the popular FIFO option, the more balanced WAC option, or the minority LIFO option, your inventory management solution must be implemented intelligently. The best way to ensure the efficient, accurate, and scalable management of dispensary stock is to leverage technology in the process as much as possible.
Robust inventory management tools will help streamline everything from receiving inventory to conversions and auditing.
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