Inventory Costing Confusion Is Burning Through Cannabis Profits

For cannabis cultivators, the cost of a crop doesn’t begin at harvest—it starts the moment a clone hits the tray. Yet, shockingly, a large portion of the industry continues to misclassify, overlook, or miscalculate these early-stage costs. The result? Skewed financials, regulatory risk, and lost revenue.

From small-scale growers to multi-state operators, the cannabis sector is grappling with inventory costing in ways that no other consumer product category has before. And the misunderstanding isn’t just technical—it’s expensive.

The Hidden Costs Growing in the Grow Room

Inventory costing isn’t just about tagging a price on your finished product. It’s about tracing value from seed to sale.

Many growers don’t realise that what’s sitting in their veg room—those leafy green pre-flowers—already holds monetary value. That’s raw material inventory. Yet too often, the financial reporting doesn’t reflect that. Instead, everything gets lumped together post-harvest.

It’s a bit like baking a cake, selling it, and then trying to guess what the flour cost afterwards.

Here’s where the real confusion sets in:

• Labor during early growth phases is frequently expensed rather than capitalized

• Nutrients, light, and water are treated as operational costs, not production inputs

• Overhead like depreciation on growing equipment isn’t tracked to product

Without a clean method for converting cultivation costs into finished goods, financial statements quickly become fiction.

Accounting Standards Don’t Bend for Bud

General accounting principles haven’t changed just because cannabis is federally restricted in the U.S.

Under standard cost accounting rules, inventory must include all costs incurred to get a product ready for sale. That includes:

• Purchase price of materials

• Conversion costs (labour and manufacturing overhead)

• Storage and handling expenses

• Quality control and indirect labour

If you’re a licensed cultivator producing flower, extracts, or edibles, these rules still apply. And the kicker? Your Cost of Goods Sold (COGS) calculation will directly impact your tax liability under IRS Code 280E.

Mess this up and you could be handing more money to the IRS than you need to.

From Clone to Cure: Where the Dollars Go

Let’s break it down with a simplified example of where costs accumulate during the cultivation cycle:

Many operators miss this level of tracking entirely. Instead, they expense the lot—and wonder why their margins look brutal.

Financial Impact? It’s Worse Than You Think

Getting this wrong isn’t just an accounting error. It’s a risk to the entire business.

For example, undercapitalizing inventory means overstating expenses, which could:

1. Understate assets on your balance sheet

2. Inflate your Cost of Goods Sold

3. Slash reported profits

4. Raise red flags for auditors and regulators

Some operators find themselves scrambling when facing licensing reviews or investor due diligence.

One CFO at a California-based mid-size grower (who asked not to be named) said it bluntly:
“We got hit with a state audit, and it turned out our costing assumptions were, frankly, guesses. We had to restate two years of financials.”

Why Operators Still Get It Wrong

There’s no shortage of cannabis-specific ERP platforms or accounting software. Yet, the confusion persists.

In part, it’s cultural. Many cultivators come from agricultural or legacy backgrounds, where paperwork wasn’t always a priority. But now, as cannabis straddles the line between agriculture and regulated pharma, the bar is higher.

Another issue? A lack of communication between finance teams and production staff. The growers know what goes into each crop. The accountants, often siloed, don’t.

And let’s face it—accounting in cannabis isn’t sexy. It’s hard to get excited about spreadsheets when you’re walking through flowering rooms filled with 8-foot colas.

Still, ignoring it comes at a cost.

A Path Forward—If Operators Are Willing

Fixing inventory costing means investing time upfront. It’s not glamorous. It’s not fast. But it’s doable.

Some steps that have helped operators tighten up:

• Map out each stage of production and assign cost centres

• Capitalize early-stage labour and indirect costs properly

• Use batch-level costing to track variations between harvests

• Sync production logs with accounting tools weekly, not monthly

And perhaps most importantly, educate your team. Not just the accountants—but the cultivators too.

“You can’t fix what you don’t understand,” says Erin Mitchell, a cannabis CPA who’s worked with operators across Oregon and Michigan. “When the head grower knows how his choices affect COGS, magic happens.”

The Bottom Line? This Isn’t Optional

As the cannabis sector matures and margin pressure tightens, sloppy accounting isn’t just a nuisance—it’s a threat.

Operators who continue to treat inventory costing as an afterthought will struggle. Whether it’s tax season, M&A, or compliance audits, financial transparency is no longer a luxury.

It’s a survival skill.