What is the smart way to determine how much and what variety of inventory I should have on hand? It’s an important question. Whether you are a grower, processor or dispensary, inventory is an investment for your cannabusiness. And like any investment, it’s important to consider how much you will invest and for how long.
How is inventory an investment? For starters, it costs you cash. You are either paying for seeds, soil, pots, water, and electricity if you’re a grower; cannabis and other supplies if you’re a processor; or flower, tinctures, edibles, and all kinds of paraphernalia if you’re a dispensary. In addition, you’re paying labor to grow, process and prepare inventory for sale. Lastly, you’re paying rent or some kind of storage costs until you can get it out to your consumer. Inventory (or cost of goods sold) will likely be the highest cost you have on your income statement, and may very well be the highest valued asset you have on your balance sheet.
One differentiating factor with inventory investment as compared to other types of investments is that it generally doesn’t increase in value the longer you hold it. In fact, it may reduce in value as time goes by, particularly if it has a shelf life associated with it. Hopefully you’re not going to have products sitting in inventory for months on end, but it’s definitely something to consider when you start making decisions about when and how much to buy or produce.
Acccounting nerds like me have a solution for this and like most things in our world, it requires a measurement. In this case we measure what your inventory turnover is, turn that into number of days inventory, then decide if it’s too high, too low or about right. Sounds like a story about some bears and a blonde doesn’t it? No fairytales here, this is a critical measurement that will tell you an important story about your business. First let’s talk about how you calculate inventory turnover.
Inventory turnover is calculated by dividing your average inventory by your annual cost of goods. Here’s an example to help you understand it. Let’s say you have counted your inventory of product on the shelves in your dispensary at year end and the cost of that inventory is $30,000. The cost of goods sold on your income statement for the full year is $335,000. The inventory turnover ratio is calculated as follows:
$30,000 inventory ÷ $335,000 cost of goods sold = .09 inventory turnover ratio
The ratio of .09 doesn’t mean all that much on its surface so I like to turn it into something more meaningful, by taking that number and multiplying it by 365 days as follows:
.09 X 365 days = 32.85 rounded to 33 days
This means that you have 33 days of inventory on hand or that, in general, you have to replace your inventory every 33 days. To me, the number of days inventory is a much more relevant piece of information. If you are maintaining inventory balances on your balance sheet of $30,000, then you are spending $30,000 every 33 days to keep that inventory at the same level.
What else is important about this number? What if the shelf life of your product is 2 weeks? If you have 33 days of inventory, you likely have some product that is going bad before you can sell it because it is taking you 33 days to “turn it over” (sell it).
What if this number was 7 instead of 33? That would mean you are replacing your inventory every 7 days. That seems rather inefficient in terms of buying new product weekly but it might be required if the shelf life is low.
Something else to consider is what variety of inventory you are going to keep. Will you grow 20 different strains or 6? Will you produce 3 different types of edibles or 12? Will your dispensary sell 50 different strains (I saw this on one website) or 10? I wonder if the dispensary with 50 strains knows how many days inventory they have of each strain…
You must have a solid accounting system to help you make good decisions about what and how much to invest in your inventory. If you have set up your system correctly, it should be able to tell you which products are selling the most rapidly and which products are simply taking up space. You can break your inventory down by product and calculate the number of days inventory you have of each product. Some systems will allow you to set par levels, that is, when inventory of a particular product gets down to a certain amount (that you set) it will flag you to order more. A very handy tool.
You can spend hours or even days every month analyzing your inventory and if you do, you will learn a ton about your cannabusiness. However, making some relatively simple calculations of inventory turnover and days in inventory will go a long way toward helping you make your next “investment” decision.