It’s the Math
It’s The Math – is a continuation of our article Allocation – Costs – Gross Profit – Taxes and the underlying financial model which we built to perform calculations. We note for the reader that our calculations in this article do not address income taxes and for a cannabis business, IRC Sec. 280E can dramatically increase the effective tax load. The interesting consequences of creating this financial modeling of California’s cannabis industry with variable inputs, we can experiment with changes in pricing, costs, taxes, and profits throughout the movement of commercial cannabis from grower to consumer. The consequences of such experimentation provide insight beyond speculation and “intuition”.
We begin our sharing of some of these insights with the California Cannabis Cultivation Tax [“CCT”].
If we decide that CCT should be viewed as a percentage of the value of the cannabis material rather by weight, and assuming California intended CCT to be 15% tax rate based on value, the $148 CCT per pound for flower would equate to a $986 value per pound for flower and the $44 CCT per pound for trim would equate to a $293 value per pound for trim.
If we decide that a Cultivator should earn $350 per pound when production costs are $450 per pound, the price per pound with current CCT rate would be $948 per pound [$350+$450+$148]. Under such a scenario, the CCT rate is 15.61% [$148/$948]. If we reduce the sale price of the flower $650 per pound, then the CCT rate rises 18.55% [$148/$798].
The CCT calculations are rather simple. Let’s move to something a bit more complex. We begin by revisiting the starting point for our prior article.
We note that taxes represent 31.46% of ‘the pie”. Our prior article also illustrated that the same scenario with a “medical card” reduced the taxes to 24.6% of “the pie”.
Let’s reduce the Cultivator’s costs to $452 while holding everything else constant. The result is that the Cultivator’s share of the profits increases from 24.14% to 35.29%.
Let’s see what happens if [“gasp”] the Cultivator were to acquire a Distributor license and all of the Distributor’s profit were earned by the Cultivator. Under such a scenario, the Cultivator’s share of the profits jumps to $950 which is 55.88% [8.82%+47.06%] of the total profit with the same costs and margins.
The next illustration hammers home the point about the importance of the Cultivator having a Distribution license. If we drop the price to $900/pound and maintain the same mark-up for the Distributor to the Dispensary, the Cultivator’s cash profits and the percentage of the profits remains constant. Hence, the Cultivator has significant protection against a decline in the wholesale price of cannabis when it also controls the Distributor.
Let’s explore another aspect of the cost, pricing and margin relationships. Recall that we started with a model in which the Cultivator received $1,200 per pound for flower. If the price per pound were to decline to $900 per pound, and the Distributor was to reduce the wholesale price from $2,000 per pound to $1,700 per pound, the Cultivator would still earn $300 profit per pound and the Distributor would still earn $350 per pound. The point of this change is that the preceding model may be a “bit rich” for the Distributor.
There is another significant change that occurs when the scenario is adjusted in this manner – the cash price of a 1/8 package for a consumer with all taxes paid is reduced below $30.
There are a myriad of insights that can be gleaned from these rather simple exercises. We will offer some additional insights in the articles that follow.