Inventory Costing: One of Cannabis’s Most Misunderstood and Financially Critical Business Processes

Inventory costing remains one of the most misunderstood and financially consequential areas in the cannabis industry. For cultivators, the process begins in the soil. Costs start accumulating long before harvest, yet many fail to track expenses like nutrients, labor, and overhead as plants move through the stages of clone, veg, and flower.

A common issue for operators and cultivators is the lack of having a clear methodology for converting cultivation costs into finished goods. In other cases, cultivators may not realize that live plants in various stages of production should be considered raw material inventory before harvested.

Under general accounting guidance, inventory is initially valued at acquisition or production costs. These costs include purchase price, conversion (the cost to convert raw materials into finished products) and production, and other costs incurred to bring inventory to its present location and condition for sale. Production costs are also capitalized if they are related to the production process, such as depreciation of manufacturing equipment, factory utilities, maintenance of production facilities, production supervision quality control, and indirect labor (e.g., factory support staff).

Delaying the recognition of inventory throughout the various stages of the grow cycle until drying or packaging can result in understated inventory balances, incomplete balance sheets, and inaccurate cost of goods sold (COGS). This is a critical pain point. Without accounting for inventory throughout the various production stages, businesses risk missing key tax deductions under Internal Revenue Code Section 280E and risk distorting asset valuations, which can impact financial reporting, investor confidence, and compliance.

These issues are compounded in a high-cash, low-banking environment. Inventory purchases are a significant cost to retailers, and having appropriate data tools to analyze traction and product mix is very important. Cannabis businesses must comply with strict IRS and state-level recordkeeping standards while managing the limitations of Section 280E. Missteps in inventory classification and valuation can reduce operational visibility, create compliance risks, and hinder strategic decision-making.

Those who invest in accurate costing and analytical tools reduce risk, support a stronger tax strategy, and make better-informed business decisions.

Why Is Proper Inventory Costing Crucial in Tax Compliance and Outcomes?
Inventory costing is a critical tool for improving tax outcomes and operational efficiency. Under Section 280E, cannabis operators have limited deductions, which makes accurate cost allocation one of the few viable strategies to reduce taxable income. Tracking all allowable costs tied to cultivation, processing, and packaging is essential—and often underused.

To support this effort, operators may categorize work-in-progress (WIP) inventory by plant maturity—clone, vegetative, flowering—with increasing value assigned as the plant progresses. This staged approach not only helps quantify production costs but also provides the documentation needed to support tax filings. Operators who understand their true cost per unit are better equipped to set prices, protect margins, and respond quickly to market shifts. Relying on estimates or outdated assumptions often leads to distorted financials and reduced profitability.