You are considering to open up a dispensary and are trying to figure out your future profits. Congratulations on this big decision! In this article I will explain a couple of ways to calculate your potential profitability. I personally suggest using a Net Profit Margin formula. But some CPAs and financial advisors prefer the Operating Profit Margin. I will cover both formulas below.
So, let’s start with the Net Profit Margin formula. Net Profit Margin = Earnings After Taxes / Sales Revenue.
This formula considers your payments for Federal and State taxes. It gives you a percentage of gross receipts you get to keep after you pay for all of your taxes and operating expenses. And, unfortunately, the percentage of gross receipts you keep is usually pretty small.
Low dispensary profitability is explained by enormous expense for Federal tax payments, which directly results from the 280E regulations. According to the IRS 280E, a dispensary cannot deduct anything else besides the cost of purchased inventory.
This means that you won’t be able to deduct such significant expenses as your budtenders’ salaries, advertising and rent. Such disallowance of major expenses makes your taxable income higher and consequently brings up your tax bill.
Fortunately for California dispensaries, our state does not conform with the IRS and allows ordinary business deductions. Yet, Federal tax expense is still very high, and it kills many law-abiding dispensaries.
On my company website, I compare the Net Profit Margin of a cannabis dispensary to the Net Profit Margin of a regular supplies store.
You can see the actual calculations here https://redeyecpa.com/blog/cannabis-dispensary-profit-margin/
The net profit of a dispensary is only 4.5%. Meanwhile, owners of a supply store enjoy a net profit margin of 11.6%. What does that mean in simple terms?
It means that if a dispensary sells $1,000,000 worth of merchandise, its owner will get to keep only $45,000. However, if a supplies store sells $1,000,000 of merchandise, the owner will keep $116,000 of sales. Sounds bad, right? It is. But you also need to remember that it is much easier to sell a million dollars’ worth of weed rather than a million dollars’ worth of pencils and calculators.
Successful dispensaries average three or four million in gross receipts, which means more residual income for their owners.
The other common formula is Operation Profit Margin. ‘
Operating Profit Margin = Operating Income (EBIT) / Sales Revenue.
This formula does not include Federal tax expense and on paper the dispensary’s profitability is just as high as profitability of the supply store. In my calculations, that percentage comes up to 17%. As we found out earlier, this number is deceiving, since the dispensary will still have to pay Federal tax on its earnings.
Most of the dispensaries are formed as C-Corps. If we run a tax calculator, we will find out that the dispensary’s average effective Federal tax rate is 64%. As opposed to the supply store that enjoys a corporate rate of 21%.
If we add California taxes, we find out that the dispensaries’ effective tax rate is 72% and supplies store is only 30%. This kind of makes you hate supply stores, right?
As I’ve told you before, there are ways of bringing your profitability up. One, of course, is to increase your sales. The other one is to be lean with your nondeductible expenses. There is also a way to deduct a portion of your rent and employee expense.
But this requires a careful setup, and you would need a Cannabis CPA to guide you through this. And of course, we are all waiting for the legalization of marijuana. Once Cannabis gets removed from the Schedule 1 drug category, the 280E will no longer apply and huge Federal taxes will no longer be a problem.
There is also such thing as a break-even analysis. This formula gives you an idea of how much you need to sell before you break even. Sales after break-even point generate profit. You are not profitable if you never reached your break-even point. On my website, I posted the break-even formula that was specifically created for cannabis dispensaries. It may be a little difficult to follow. And if I confused you, you are welcome to shoot me an email.
This summarized how much you can make on a cannabis dispensary. Calculations for cannabis growers and distributors are different and require a different analysis.
I wish you luck in your business endeavors and please don’t hesitate to contact us. We do not charge for simple phone calls.
Daria Nagal, Cannabis CPA