Elements of the Annual Financial Statement for Cannabis Businesses

Cannabis businesses operating in highly regulated markets face rigorous financial reporting requirements, particularly when preparing their Annual Financial Statement (AFS). The AFS is not only a compliance obligation but a critical reflection of the business’s financial integrity, governance, and operational soundness. This article outlines the major elements cannabis operators must address to ensure a complete and accurate AFS, emphasizing the importance of maintaining proper accounting records, reconciliation practices, and supporting documentation.

1. Revenue Reconciliation

Accurate and detailed revenue reconciliation is foundational to any AFS. Cannabis businesses must reconcile revenue reported in their accounting system with point-of-sale (POS) data, bank deposits, and state-mandated seed-to-sale tracking systems such as METRC or BioTrack. Inconsistencies—whether due to timing differences, unrecorded transactions, or data entry errors—can trigger compliance concerns. To substantiate reported income, businesses should implement monthly reconciliation procedures and retain all supporting documentation, including POS summaries, cash logs, and deposit slips.

2. Contracts and Agreements

The AFS requires disclosure and examination of various contractual obligations and rights. Cannabis operators must ensure that all executed agreements are correctly recorded, maintained, and updated. These typically fall into four categories:

• Real Property Agreements: Leases or other real property agreements must be retained. Details regarding lease terms, payment schedules, and leasehold improvements should be thoroughly documented.
• Financing Agreements: Debt arrangements, including convertible notes, loans from private lenders, and seller-financed arrangements, must be supported by executed documents outlining principal, interest terms, repayment schedules, and any associated covenants.
• Management Agreements: In many vertically integrated cannabis operations, management service agreements govern the relationship between licensed and unlicensed entities. These agreements clearly define the scope of services, fees, and control structures to ensure regulatory compliance and avoid ownership entanglement.
• Licensing Agreements: Intellectual property licensing, whether for brand use, product formulations, or proprietary technologies, must be categorized appropriately and supported by signed agreements. These contracts may have significant implications for revenue recognition and expense allocation.

3. Vendor Testing

All vendors reflected in the AFS should undergo testing to confirm legitimacy, proper classification, and completeness of recorded transactions.

• Service Vendors include consultants, contractors, and professional service providers. Cannabis businesses must obtain W-9 forms, verify EINs, and appropriately categorize expenses (e.g., General & Administrative vs. Cost of Goods Sold). Special attention should be paid to related-party transactions requiring disclosure and additional documentation.
• Other Vendors include suppliers of cultivation materials, packaging, security systems, and other operational inputs. Businesses must retain purchase orders, invoices, and proof of payment to support reported expenditures. In states with strict inventory tracking, vendor testing may also intersect with compliance audits of product intake procedures.

4. Ownership and Employee Information

AFS preparation also necessitates clear documentation regarding ownership structure and human resources data. For cannabis licensees, this is particularly important due to regulatory scrutiny of ownership thresholds, funding sources, and employee background requirements.

• A detailed ownership ledger should be maintained, disclosing all equity holders, their respective percentages, and any changes during the reporting period.
• Employee records should be up-to-date and reconciled with payroll registers, including payroll summaries, job descriptions, and I-9 forms.

Additional Considerations for Cannabis Businesses

Given the unique regulatory and financial environment of the cannabis industry, operators should be aware of the following:

• Cash Controls and Security: Many cannabis operators transact in cash due to limited banking access. Internal controls over cash handling, armored transport services, and secure storage procedures should be documented and evaluated regularly.
• Audit Readiness: Even if a third-party audit is not mandated, preparing for an AFS engagement of high-level quality ensures readiness for regulatory reviews, licensing renewals, and investor due diligence.

The cannabis industry doesn’t get the luxury of making accounting mistakes without consequences. Regulatory bodies expect cannabis companies to maintain meticulous financial records and to be accessible at any time. Your AFS is the culmination of this discipline. If the numbers don’t tie out, or if your contracts and documents don’t match what’s on the books, you risk fines, audits, or even loss of licensure.

If you’re preparing for your next AFS or want to strengthen your internal accounting processes, contact Yeo & Yeo. We’re here to help you perform the agreed-upon procedures for the AFS so you can stay compliant, confident, and focused on growth.