Income Approach & Forecast Inputs - Cannabis Businesses (6 of 8)
Welcome to the sixth blog post in 4 Corners’ Cannabis Valuations in Washington State series! Throughout this eight-post series, we’ll be sharing information about the local cannabis industry and walking through the key concepts and challenges of a cannabis business valuation. Today's post discusses the Income Approach and forecast inputs.
Our previous blog post (#5 in the series) discussed the Discounted Cash Flow Method (“DCF Method”) and how it relies on a financial forecast for future periods. Since these forecasts are compiled by management, it’s important for valuation analysts to review and scrutinize the forecast to determine its reasonableness and rationale.
We’ve compiled a list of areas for valuation analysts to consider when reviewing cannabis business forecasts to help better understand the industry, value drivers, and risks:
Understanding revenue for cannabis growers/cultivators:
Price of cannabis – Obviously, the price of cannabis is going to be a major factor in the revenues of a cannabis-related business, and one which can be volatile and unpredictable. A valuation analyst should consider how changes in cannabis price will affect the business. The analyst should consider regional pricing, but for illustrative purposes, in May 2024, the wholesale price of cannabis was $1,008 per pound. A year earlier, the wholesale price of cannabis was $1,077 per pound.
Plants in the ground – A cannabis grower/cultivator will know how many plants they have in the ground at any one time. A valuation analyst should have an understanding of how many plants are growing and what the historic dollar yield per plant is.
Number of days in a crop cycle – Equally important to understanding the number of plants being grown is the number of days that a cycle takes from seed to sale. According to GrowWeedEasy.com, the crop cycle can take anywhere from eight weeks to five+ months, so it’s important to understand the process for the subject business being valued. This piece, coupled with the plant and price information above, should allow an appraiser to “check the math” on forecasted revenue figures.
Crop failures – An important question to ask the subject company’s management is whether they have encountered crop failures in the past and, if so, how often. Depending on the company, a crop failure could impact anywhere from a few plants at a time or an entire cycle. Some of the most common reasons for failures include:
Female cannabis plants becoming males (male plants have very little THC);
Insect infestations;
Power failures; and
Mold development.
Depending on the size of a company, a failure of an entire cycle could be devastating, especially if crop failures have not been included in the forecast.
Testing failures – A valuation analyst should understand if a cannabis business can comply with current and potential future regulations.
Distribution channels – It is important to understand a company’s distribution channel and customer base. A cannabis grower that is dependent on just a few retail stores or one distributor could be considered high risk.
Understanding dispensaries and recreational stores:
Supply Chain – An important consideration for the valuation of a recreational cannabis store or dispensary is to understand its suppliers and how it receives cannabis. Important considerations include:
The consistency of supply; and
Redundancies in the supply chain if there is a disruption in the primary supplier’s business.
Both growers and selling stores:
Form 8300 audits – A business must file Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business, if it receives more than $10,000 in cash from one buyer as a result of a single transaction or two or more related transactions. We have heard of many audits related to Forms 8300 not being filed by both growers and sellers.
Reliability of data – Recreational cannabis stores and dispensaries are involved in many small cash transactions that are difficult to trace. Growers are generally involved in fewer, very large cash transactions. In either case, working with cash increases the risk that not all funds are being tracked properly. A good valuation analyst will understand the company’s revenue-generating ability and ask about any shortfalls to ensure cash hasn’t leaked out of the business.
If you own or represent a cannabis business in Seattle, Bellevue, or elsewhere in the Pacific Northwest and need a business valuation or financial expert, call 4 Corners Financial Forensics at 425-800-4896 or schedule a video call here; we’ll listen to your situation and help you scope your project. We’d love to help you.
Stay tuned for the next blog post in this series, covering strategic value in the world of cannabis business valuations.
You can find additional installments of the Cannabis Valuations in Washington State series at the links below: