# Cannabis Companies - Reconciling Biological assets, inventories, and cash flow

Hi guys,

I have been studying MJ companies and I am having a hard time figuring out the relationship between biological assets and CFO - cash flow from operations.

So my theory is: FV adjustments to inventories when biological assets are harvested could potentially understate CFO.

I’ll detail out a scenario and need a second set of eyes to determine if my accounting is correct or not.

Example (numbers are completely theoretical):

An MJ company invests \$1000 into a MJ plants (including capitalized cost) which are considered a Biological Assets - Cash outflow is \$1000.

4 months later the MJ is harvested, say 1000g at \$5/g = \$5000 of MJ, assume \$0 harvesting cost (no capitalization). My understanding is when biological assets are harvest they enter inventory at FV less cost to sell. In this case,

DR Inventory \$5000

CR Biological Asset \$1000

CR FV gain on harvest \$4000

Assume that no inventory is sold at year end.

Revenue \$0

FV gain on harvest \$4000

Profit      \$4,000

Flowing into Cash flow statement

Profit \$4000

Less: FV gain   (\$4000)

Less: Increase in inventory   (\$5000)

CFO = (\$5000)

CFI = (\$1000)

So, in this case, even though my initial cash outflow was \$1000, I’m recording a operational cash outflow of (\$5000) simply because of the FV increase in the MJ I harvested.

Can someone reconcile this for me because ultimately the cash in the bank must match the cash in the books? If this is not right, where is the additional cash outflow coming from with respect to (\$5000) in inventory?

Thanks.

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Most of the financial statements I’ve read from the sector appear to be complete BS. Or, more likely, I’ve grown financial illiterate in my old age. So, instead of doing my due diligence, I just bought a handful of them and figure one will pan out.

is the increase in asset after harvesting truly treated as profit? i would think that the increase in asset value would be offset by a deferred revenue line and then converts to cash flow when product is actually sold. seems stupid to book a profit when it still sits on the balance sheet as an asset though i could be wrong if it is treated as a marked to market commodity rather than a work in progress product. if it is booked as deferred revenue, then it would not be considered a cash profit until the product is delivered and off the balance sheet and cash is received. i’m not an accountant but just is the most logical shifting of values in my mind.

Yea, the FV gain is treated as a gain on the P/L, at least from my understanding from the IFRS standards. It’s not deferred revenue because we haven’t received any consideration for products not sold.

And it is this gain that increase inventory, which seems to artificially reduce CFO. This is precisely the problem that I can’t wrap my head around.

inventory should be booked at cost or retail value. whichever is lower. so for your scenario its at cost. if market value falls for it, then you write that **** down.

but to book it at market value and mark a gain when it isnt sold is bs accounting!

I love my cheese. I got to have my cheddar.

^ if it is a commodity though, like copper or gold, and its value is fairly reliable, unlike say toys or clothes, i don’t see why they can’t book the gain generated through their mining/cultivation process.

i think from the CF statement perspective, i imagine the profit booked due to generating value during the cultivation process is offset by a line item like “unrealized gain on changes in FV of biological assets”. this is on WEED’s CF statement and i imagine this allows for cash flows to be reduced by the profit booked in the income statement.

^ yes Matt, your CF point I agree with.

I’ve reflected that above in this section:

Flowing into Cash flow statement

Profit \$4000

Less: FV gain   (\$4000)

Less: Increase in inventory   (\$5000)

CFO = (\$5000)

So what I don’t get is, from a cash perspective, actual cash outflow was (\$1000) for the year, but CFO is (\$5000), despite the company not actually spending \$5K. It’s almost like not selling the product with FV gain is actually counting as negative cash.

i simply disagree. i’m not seeing CFO at (\$5000) on actual balance sheets.

for WEED:

profit equals \$4000

adjusted down by (\$4000) for increase in biological assets

equals no change in cash flow.

biological assets convert to inventory once they are actively saleable. there is a value adjustment when the biological asset becomes inventory depending on market value at the time. only the value adjustment is included in the cash flow when a biological asset becomes inventory.

^Thanks Matt. I actually think we are talking along the same wavelength.

It’s just that for WEED, the inventory adjustment is captured in “changes in non-cash working capital items” - Note 23. For the recently Q3 2019, they reflect a decrease in CFO of (\$109,182), relating to inventory, which  I’m not sure if due to purchases but more likely from transfer from biological asset to inventory.

So, I’m thinking they were able to write up their inventory to MV when transferred from biological assets, but then if the product is not sold, the change in working capital due to inventory increase would be reflected as a decrease in CFO. It seems as though it is accounting for losses of cash that you could have earned if you had sold the inventory. Trying to understand if this thinking appropriate.