Podcast Transcript
Blaine: Hello everyone. This is Blaine, the CEO of Distru and this is episode one of the Distru podcast. Here today, we have Doryn from Bleux Financial Solutions. I would love for you to start by just introducing yourself.
Doryn: Thanks, Blaine. As Blaine said I do work for Bleux Financial Solutions. We provide accounting services mainly to start up in small businesses. Prior to working for Bleux Financial Solutions, I worked for one of the largest distribution companies in the state of California as their controller. Through that, I got a lot of first hand experience with the cannabis industry, the regulations and also working with Distru as an inventory software system.
Blaine: I can personally attest to her mastery of inventory-based accounting in the cannabis industry which is why we have her on as a guest. On that note as you know, financials are complicated in the cannabis industry because inventory-based accounting is complicated and there’s a lot of specifics in the cannabis industry that make it double complicated. I’d love to start with, what do you think are the most challenging aspects of the cannabis industry for accountants right now?
Doryn: I think that the biggest thing is that owners of most of these companies come from the black market. They're used to being incentivized to not keep records of everything. Most of their deals that they're use to making are just a verbal agreement between two people. They're not used to actually having to produce in invoice for example. That alone is a very difficult obstacle to try get around. Also, most of these people that being said that they don’t want to have a lot of records. They also are keeping like a very small group. They're used to managing maybe one other person.
Now, they're trying to manage a team of 50 people and honestly most of them lack those management skills because it’s just not something they’ve had to have before.
Blaine: What do you do as an accountant coming in to these types of companies to help them navigate to getting to a better financial setup?
Doryn: Educate, I feel like the majority of my job for the past, I would say, two years has just been educating people. That’s probably the most important thing in my opinion for accountant and I feel like attorneys as well to do is just to educate the people that are coming in to the legalized industry. Setting in good internal controls and creating SOPs for the clients can be so helpful and its things that they don’t realize they need and they jump into the industry very quickly. There’s a lot of regulation, there’s tons of paper work that goes around the licensing itself. I think just educating them on what records they do need to keep and how to keep those records.
Blaine: There’s a lot to that education piece. I could imagine some aspects about data entry from the sales reps to charge of accounts and how they map that to their financial system. What do you think the most important aspects of that are? Like just more detail on that education.
Doryn: Yes. Just to make our listeners aware of the 280E Tax Code which is a tax code that was put in place basically to keep drug dealers from claiming tons of income and not having to pay really high taxes on it. They're not allowed to deduct any of their ordinary business expenses. Whereas a company that’s selling t-shirts for example can deduct all of their wages, all of their any business supplies such as like their paper or things like office supplies that they're buying. They can deduct all of those things from their revenue.
In the cannabis industry, they can only deduct their cost of goods sold. Then there’s also the education piece around what is cost of goods sold, because cost of goods sold doesn’t include all of the inventory that you purchase. If you purchase a million dollars’ worth of inventory and you only sell half of it, you can only deduct that the cost of the half that you sold that’s the cost of goods sold. The education piece just around the simple like what’s the difference in an asset and a cost of goods sold but then also like what things can certain sectors or licensees I should say, what deductions can they claim because it’s different between cultivators, manufacturers, distribution, retailers.
For a retail, for example, can deduct very, very little other than just the actual product that they're purchasing. Even any employees, wages, things like that they can't deduct those cost and then they're paying tax on their gross profit. Therefore, if you sell a million dollars and your cost of goods sold is only 500,000, you have $500,000 that you could pay up to anywhere from 21% or higher on especially if you aren’t accounting for it correctly and then you have to deal with an audit.
We have one company right now that has spent over a quarter of million dollars in the last year trying to finish an audit and that’s just for them to be acquired by another company.
Blaine: I’d love to dive more into that audit. Is that audit triggered by the California cannabis government or is that just a financial audit by the IRS?
Doryn: It’s a financial audit in order to be purchased. I don’t know. I'm sure that most people have heard that a lot of people are being purchased by Canadian companies right now. Before they can be purchased and put on to any public market they have to have a verified audit done. That’s the reason for the audit. It’s not an audit that’s being required by the IRS right now. However, in Colorado I think it’s over 75% or maybe even higher than that of the cannabis companies are being audited by the IRS.
Blaine: Okay. You’ve seen that happening in California?
Doryn: I have not seen them start happening. For example, whenever I did work at the distribution company, we had the BCC come by and they will ask for financial records but usually they're asking for one or two samples and it’s not like a full-blown audit. I have not seen any audits happening in California, IRS audits that is in California as of right now. Most of the audits that I’ve seen have been voluntary audits that just the board wants to do.
Blaine: Cool. I think that this is getting into a complicated territory but I’d love for you to break down. What are all the parties that a cannabis operator needs to be worried about from the perspective of a financial audit? [0:07:10 inaudible] federal and then there’s also the state financial and the BCC which is really not even just a taxing agency, that’s the Bureau of Cannabis in California. What are all of these different systems they need to be aware of?
Doryn: There are probably so many that I might miss a few just off top hand. The California Department of Tax and Fee is the state regulator for reporting taxes. General businesses report their sales tax to— Cannabis companies have to report their sales tax as well as cultivation and excise tax. On the note of cultivation, excise tax it’s just crazy in itself. Cultivation tax is one of those things you don’t see in any other industry. No one else pays tax on a product that they're selling. They don’t pay the tax to their customer on a product that they're selling which is how cultivation tax work.
From an accounting standpoint, it’s very backwards and I’ve tried to get a clear understanding from the CDTFA exactly how that should be shown in an invoice and there’s honestly no clear answer at this point in time. That’s just one of the hurdles that’s caused by one. Each municipality has usually a regulatory body so for example, Santa Rosa City has a tax rate and then Sonoma County also has a tax rate so depending on which municipality you're in and then you also have to worry about the employment tax or a payroll tax which is a whole another burden because half of these companies can’t get a bank account.
It’s really difficult to pay payroll tax in cash. I'm not going to say it’s not possible but it is very difficult to do. The EDD would be another agency for people to have to report to as well as the IRS on the state side and the federal side which are completely different filings since the state does not impose 280E Tax Code and the federal government does impose 280E Tax Code.
Blaine: Okay. Federal, state, IRS then state, municipality, city and then EDD for employment and then if you want to go on the Canadian market, you need an independent audit to get on there.
Doryn: Yes.
Blaine: You said that it’s really hard to pay people in cash as an employee. What makes that so difficult?
Doryn: It’s not the paying the employees, it’s paying the state and the federal payroll tax. Without a bank account just makes it more difficult. You're not supposed to mail the cash to them so you would have to go to a state office and try to pay that, would have to be an appointment set up to do those types of things. It just makes the entire process a lot more difficult as opposed to my clients that do have a bank account or able to click a button and pay their payroll tax.
Blaine: Why is paying payroll tax to the state and the federal more complicated than just their normal tax filings?
Doryn: The state of California, the only other tax that would need to be paid in cash which I guess if people did have sales tax. For example, retailers would have to pay sales tax and they would most likely just set up an appointment the same way that people do for their excise and cultivation tax.
You schedule an appointment with the CDTFA, roll up to an office with anywhere from 20,000 to $100,000 of cash. Hopefully you are in a somewhat armored vehicle whenever you're doing this and then you usually pull up to an office with about five guys standing outside with AKs to protect you and you walk in with your bag of cash and give it to the state.
Blaine: Okay. Noting, AK, got it.
Doryn: It’s pretty intimidating honestly…
Blaine: They actually have AKs there?
Doryn: Yes. It used to like the first time that I went to drop a tax payment off, it was not that secure. There were two cops standing outside and just looked like they were standing there the last time that I went to drop it off. I haven’t been to drop off tax for any client for probably six months but the last time that I did have to do it, you pulled into a gated area and I think that there were three cops that had AKs. Once you’ve got into the building, there were two more officers to escort you to the door.
Blaine: Geez. Okay. Let’s take a different direction from the taxes. I'm sure that that’s complicated even if you're not a cannabis business but I’d love to dive into that 280E you brought up. I'm familiar with it to some extent but you said that the federal follows 280E, and you said that state does not, and then this affects cost of goods sold. Can you dive into more detail on how that dynamic plays out?
Doryn: Yes. The state allows you to deduct your ordinary business expenses as well. The tax filing itself isn’t super different. It’s just what is included in your deductions and what is not but the cost accounting portion of it alone is what makes the cost of goods sold section very hard to account for. On the federal side, you want to try to include as much as you can and make sure that you're not missing any cost of goods sold since you will have a higher tax liability.
In order to do that to make sure that you're including all of your cost of goods sold, you really should hire a full-time cost accountant. That’s something a lot of these companies don’t budget for in the beginning whenever they're doing their business planning. Just a full finance department I don’t think is what most of them picture them ever having and that’s what they—honestly most of these companies need and even from the beginning they definitely should hire a full-time cost accountant or at least a part-time book keeper and a part-time cost accountant.
It should be someone that’s very familiar with manufacturing of products and what all needs to go into those and how to break units down and really get to that actual cost of the end product. For example, a manufacturer, you're going take hundreds of pounds and possibly turn those into a concentrate and then later sell them as a little gram cartridge that somebody’s going to smoke. To be able to make sure you account for the labor that’s touching the product, the square footage of the warehouse… how much rent are you paying on the square footage of the area that’s actually being used to produce the products?
There are multiple things that go into the cost of that final product and it really takes having someone in the position that knows exactly what goes into the cost of it and how to create the spreadsheets or use a software system that does that for you.
Blaine: On that note of the cost of goods sold, just got a little bit more color on what you can and can’t file. Are you basically saying you can't even file the actual cannabis though and you just started to able to file all these other layers or can you actually count cannabis as a cost of goods sold?
Doryn: You can count cannabis as a cost of goods sold. Yes.
Blaine: Federal and state level?
Doryn: Yes, because it is technically like that is the product that’s being sold. That is very much a cost of goods sold. That would be the main thing is the flower and a lot of times companies will only count the flower and they don’t include all of the other cost. I'm sure if you guys have been to the dispensary and bought any flower or a pre-roll or a cartridge lately, you see all of the packaging that goes into that especially with the [0:15:42 inaudible] system regulations right now. It’s a ton of packing so that’s a huge cost and a lot of people are not accounting for it correctly if they're accounting for at all.
Blaine: The 280E was what enabled that cannabis to be filed as a cost of goods sold, right?
Doryn: Right, it is.
Blaine: Okay. Cool. Back to what you’re hinting for, building out your financial team. This is where your company comes in, Bleux Financial Solutions, but how do they decide if they should outsource or build in-house and if they do go outsource or in-house, how do vet for the right people?
Doryn: That’s a very good question. I would say that they should definitely, like I said, have a full-time cost accountant. A lot of people will have like an admin person that’s supposed to be for example digitizing all of the financial documents whether it be invoices from vendors or sells receipts where they're selling product. They're trying to have their admin person not only digitize it but then also try to put it into their accounting software and account for it. My first suggestion to any company is to definitely separate those duties and hire at least one full-time cost accountant that can help with digitizing those documents as well as doing the accounting.
Then, outsource for possibly like a CFO. That’s how I see Bleux for a lot of these companies is we’re more like a CFO or an external comptroller where we just review stuff, we put in the internal controls and then we review the review the process and review the data and make sure that it’s correct. Now there are definitely some clients that we end up doing a lot more than that. We’re almost their cost accountant as well. We definitely can handle that but my suggestion is always to have at least one full-time person and that would be for start of.
As soon as you start, you should have that full-time person and then as you build your company, you're eventually going to want to segregate each section of your accounting department so that you have your accounts payable manager, your AR manager, your payroll person. You have your cost accountant that works on the inventory section of your financials. I hope that answered that question for you.
Blaine: Yes. There’s a lot of stages and like how and when. I’d like to get a little bit tactical with that to give more color for the operators. At what annual revenue should you hire that cost accountant? And then same question for that CFO.
Doryn: I think that from the get-go, one of the first people you hire on your team. As soon as you start acquiring inventory, you should have that cost accountant. Before revenue starts, I would say you should have a cost accountant. Once you get up to, when you start hitting 100,000 a month then you should, I think the CFO or some external accountant should always be there as well, you should have those two people pre-revenue. Once you get up to about a 100,000 a month is whenever I suggest bringing on at least one other person.
By the time you're hitting 250,000 a month is when you should definitely segregate it into accounts payroll, AR, your cost account, and then possibly use someone else to do payroll.
Blaine: You said that you should start with both the outsource comptroller which I'm assuming that’s like that data entry and SOP checks. Could you get away with just that outsource person for a little while or just your cost accountant for a little while because I'm sure that cannabis operators are a little averse to going too hard on hiring when they’re just trying to tell some weed.
Doryn: You're very correct. I'm not going to say they can't, I’ve seen it happen and I have one client in particular that I have in mind right now that’s succeeding and I was that external person for the first couple of months of business. As soon as they started getting close to like the 75,000 mark, they were starting to feel very overwhelmed and they wanted those real-time reports that I personally as an external comptroller with other clients, I can produce. I would be working like 15 hours a day in order to be able to get that data in and be able to take of other people as well.
I would say that it would be more beneficial to hire someone full-time internally and then just have your accountant do a monthly bookkeeping review. I mean, you're only going to pay maybe $250 a month to have them do that review. I feel like most cannabis companies can afford to do that especially if they're not splurging in other places. Since it is your financial records and that can cost you, like I said, we a client that is currently spent a quarter of a million dollars in the last year because they did not do it correctly in the beginning.
Blaine: This cost accountant seems really, really important.
Doryn: Yes.
Blaine: After getting that person, what tip or trick would you tell an operator that doesn’t know any of these stuff, how to see if the accountant is actually a good cost accountant? Because I can completely attest to the fact that accountants can say they can do anything with money. It’s hard to really test what their actual specialty is. How can you make sure that you have a great cost accountant?
Doryn: One of the big things is to have someone that’s familiar with the industry. It’s really difficult… even someone that has cost accounting background that they’ve worked in a huge manufacturer producing guitars or whatever it may have been that they're producing in the manufacturing doing cost accounting for that. It’s knowing about what goes into making that product so that whenever you do get like the source documentation back from your production team and your like, “Wait. You guys made these syringes and it’s supposed to be, for example, 20 to one but you only used CBD in here, there’s no THC crude.”
Little things like that that just ask in the interview like, “Well, what knowledge do you have of the industry?” You honestly want someone that has good knowledge of it and then knowing what software systems they’ve used and to the extent that they’ve used those systems. I have seen in multiple interviews where people are like, “Yes, I’ve worked for a manufacturer and I’ve done cost accounting” then you realize that, no, they were… for example like in quick books to build an assembly, it’s very much like Distru assemblies.
You type in an input and you get an output but there’s a lot more that goes into that beforehand such as the cost of the build of the material. So, you create that originally. It would be like a Distru preset which I wish our entire audience knew what I was talking about but the preset I would say like you have your flower that cost $500 a pound. You have your drawers that cost a dollar a jar, the tops, the labels and it has each of those cost. In QuickBooks it also does that and it gives you your total for each item that that’s going to cost.
You would need your cost accountant to pay a lot of attention to detail to make sure each one of those units that are going into the final unit have the correct cost. You want to make sure that they would know where to pull those costs from. To answer your question, “How would you vet that and how would you ask those questions?” You would just really have to ask something about the software that they’ve used and get them to go into detail about it. If they can tell you basically the steps that I just said that, “You're going to need and this to build an item.” That’s really, I guess the keyword you want to hear is hear them say like to build something and know that they understand how to do that within a software system.
Blaine: Absolutely. Awesome. Well, let’s take this a little bit in a different direction. I’d love to know more about how you’ve got into the cannabis industry?
Doryn: Yes. I moved to California, I guess it’s been like two and half years ago. I graduated with an accounting degree and I just really love the thought of being able to work in the cannabis industry. It was on the verge of legalizing in California and I had a great opportunity, some really awesome friends that allowed to me to be able to move to California. I had a friend that actually got me a job on a cannabis farm in Ukiah, California. I was supposed to start helping the guy keep track of his inventory and his cost and basically helping put a set of books together because he didn’t have that.
He ended up having a few of his workers leave. I basically just started like transplanting and doing manual labor which I thought was awesome. It gave me a completely perspective of the cannabis industry than I was expecting to have. Once harvest season was over, I started looking for jobs, accounting jobs, in the industry. A friend of a friend sent me to the cannabis distributor that I originally started working with and I worked there for about a year and half as their comptroller. They grew to be—whenever I started—I started in 2018 and 2017, I think they had like 100,000 sales.
By the end of 2018, I think they ended up to 5.5 million in sales. That was my first experience really in the accounting section of this industry. Actually, Bleux they were the accountants that we were consulting with and they had an opportunity open for me to start working for them directly. I jumped on that opportunity and have been working with them since. Mainly, I just work our cannabis clients.
Blaine: Cool, awesome. Cannabis industry is great. While we’re talking about the industry, we’re talking a lot about right now. Money is pouring in and I'm personally seeing a lot of operators from other industries and COOs of other spaces coming in. What do you think the biggest problem that cannabis industries are going face in the next five years around financials and accounting that people should get ready for?
Doryn: Honestly, I'm hoping that within the next five years it’s federally legalized and therefore there will be slightly less issues. That will mean that I feel like a lot of companies are going to try to get into the stock market and start having those investors and being publically traded meaning that there will be way more audits and that their financials are going to be deeply scrutinized. I think that that would be the biggest issue in California. I see us following the same trend that’s happening in Colorado that I mentioned before. Basically, all of the cannabis companies are being audited by the IRS right now.
I feel like in the next two years, we will definitely have that and then within the next five there will be companies that are being traded publicly.
Blaine: Yes, just get your books in order and a big part of that is banking which I’d love to know from your perspective—because my perspective of banking is chaos and I think a lot of this does center around the lack of banking. What is the current status of banking in the cannabis industry in California? Have you seen a noticeable change in the last year around banking?
Doryn: Yes. I definitely would say I’ve seen a change not necessarily a good change. I feel like a lot of the big banks such as Wells Fargo and Chase, they’ve gotten a lot smarter as to what cannabis companies are and where to look for those and how to look for those. Before if people are depositing too much cash into the bank, that would usually get their bank account shutdown. Now, I feel like a lot of those big-name banks have teams that are actually just going to—if there’s any question about it, they're going to start look on Instagram or any social media and see that it’s a cannabis company and instantly shut the accounts down.
We currently do not have a cannabis client that has not had at least one bank account shutdown. That’s a huge issue. Luckily, none of those assets have been taken but it is definitely a huge pain to deal with whenever you have an account closed and then trying to open another account. There currently are that I know of. Three banks and other credit unions actually in the state of California that will openly bank cannabis companies. Most of them have a compliance audit software that they require you to use as well as a financial audit software that they require you to use just to like submit financial data and submit.
They require like this audit that ask you questions such as, “Do you have a billboard that’s so many feet from school?” things like that to make sure that you're staying compliant. It’s difficult as well to deal with those banks but at least you know that your money is safe and you don’t have to worry as much about it being shut down.
Blaine: Awesome. Yes, absolutely. Those auditing tools, I’ve seen those they can get pretty finicky and crazy. I saw one bank they actually had like a personal auditor for every actual cannabis company and they checked their books daily. It’s intense. I’d like to know one more thing about kind of like California and cannabis and accounting which is metric. How do you see metric affecting your job as an accountant?
Doryn: It’s a lot more steps. Personally, I haven’t used the software a whole bunch. I feel like I'm just going to bash metric and I hate to do that because it is a tracking trace software that’s supposed to be meant for good but the actual software doesn’t really make sense for most sectors of the industry. Most licensees—it’s mainly centered around cultivation and that’s only one step of it. I, personally deal mainly with manufacturers and distributers.
For example, whenever we create an assembly to produce let’s say 1,000 [0:31:08 inaudible] that’s sitting in my inventory as one lot of 1,000 [00:31:11 inaudible] and then metric for some reason thinks that if you sell that product then all of a sudden becomes another lot which to a lot of people you’re like, “Well, does that really matter?” but from an accounting standpoint, it’s really nice to keep those lots together because those lots have certain cost. Whenever you start breaking the lots down, they look like maybe those lots didn’t cost the same but actually they did. They're all the same lot. That’s one of the biggest issues around metric and accounting for it.
Not to mention the bandwidth that a company has to have. I feel like keeping up with metric is a full-time job for one person and it’s not the accounting person. If you put that solely on your accounting person, you're not going to end up with real time results.
Blaine: Yes, absolutely. I think that we’re going to see in the next year how this is actually going to play out. Thank you so much for coming on. This is great. Feel free to give everyone your information, how to reach you. Thank you for coming on.
Doryn: Sweet. Thank you for having me. I really appreciate it. I enjoy talking with and your team about this stuff all the time. Anytime you guys want to reach out, please do. If anybody else would like to reach out, the best contact to reach me at is doryn@bleux.net.
Blaine: Awesome. Thank you, Doryn.
Doryn: Thanks Blaine, later.
