Year-old images published by The Sun appeared to show Grealish taking the substance that is described as a legal 'high'.
"I spoke to Jack first thing this morning," Sherwood was quoted as saying by the BBC on Thursday. "I explained to him his behaviour can't be tolerated.
"He is now in a responsible position as a professional footballer. He's got to make sure it won't happen again, he's assured me it won't.
"I'm not worried. There is only one form of discipline, that's self-discipline, that's what really matters," said Sherwood.
"Jack has to take that on board now. This is an eye-opener for him, he has to realise he has to be very careful who he can trust out there."
Liverpool's Raheem Sterling was at the centre of similar allegations earlier this month when The Sun's website apparently showed the England forward taking nitrous oxide.
Grealish, 19, has burst on to the scene this season and he played a key role in Villa's 2-1 victory over Liverpool in Sunday's FA Cup semi-final at Wembley.
Sixth from bottom Villa take on Premier League champions Manchester City at the Etihad Stadium on Saturday.
(Writing by Tony Jimenez, editing by Toby Davis)
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