6 minute read
Financial Success Requires a Plan
By Keith L. Lavery, PCAM, CMCA, CCAM
The key to an association’s success is adopting a sound financial plan, and then consistently monitoring that plan. The plan will include the annual operating budget, reserve study, and regularly reviewed financial statements. These tools will help ensure the association has sufficient funding to maintain the association’s amenities and services, and to provide for the current and future repairs and replacement of association assets when needed.
RESERVES
The reserve study is a long-term financial plan to help ensure the association has sufficient funds available to repair and complete major repairs to all the assets for which the association is responsible. For most associations, the reserve fund will be their largest financial asset, and correspondingly, the amount of the regular assessment committed to reserves each year will be one of the most significant budget line items. The reserve fund is intended to collect funds through assessments, to accumulate needed funding for repairs when they are needed. Assessments are collected regularly from owners during the lifetime of the asset while owners are members of the association. Think of it somewhat like a pay as you go. The association may not need to replace the roofs while you own the home, but when it is time to replace the roof, you have contributed your equitable share to that inevitable project.
Therefore, it is best to begin working with your reserve study professional early in the budget process to establish a stable reserve contribution level to meet the association’s long-range plan and obligations. Review the reserve study for adequacy of assets included (some may need to be added, some may need to be removed), reasonableness of remaining useful lives, current fund balance, and projected fund balance over the life of the study. Pay particular attention to percent funded at least over the first 10 years of the study, as well as your minimum fund balance. The board should have an adopted policy of the minimum fund balance over the life of the study. This could be as low as zero (high risk tolerance) to 100% of estimated funds needed in each year (very low risk tolerance). From this data, with the assistance of your reserve professional, you will have the amount needed to set aside in the reserve fund for the current budget year; typically referred to as the annual reserve contribution.
OPERATING EXPENSES
The second part of the budget process is for the board to thoughtfully consider the association's anticipated annual operating expenses that will be needed for the association to meet its obligations pursuant to the governing documents and statute requirements. These are mandatory expenses that the board must fund to meet the operating needs. The board should annually review all its contracts with vendors to ensure current
scope and costs are in line with needs and expectations, review insurance policies with your agent, and assess preventative maintenance needs for the upcoming budget year.
In addition, the board must also review the discretionary items considered for the budget. These are items that enhance the service level within the community but are not mandatory. Some items to consider are: plant replacement policy, pool heating schedules, social activities, etc. These areas are where the board has the best ability to impact cost of operations and assessment levels.
ASSESSMENTS & OTHER REVENUE
The final budget component is revenue. This is the source of income by which the association will be able to fund all the items discussed previously. Typically, most of this income is from the regular monthly assessments collected from all owners. However, there are opportunities to collect other income (use fees) to offset the cost of operations. These may include clubhouse rental fees, rental registration fees, architectural processing fees, newsletter advertising. The key to considering these as part of your budget is: are they consistent reliable and collectible. Budgeting income rates despite varying percentages of value, and others establish assessment rates based upon a different calculation entirely. Governing documents also determine the frequency in which assessments are owed, typically, monthly, quarterly, semi-annually, or annually. While assessment levels are certainly a concern for homeowners, the board ultimately owes a fiduciary duty to the association and its members to maintain the common areas, fund the reserves for from sources other than assessments should be used conservatively.
In most associations (particularly condominiums), there are three types of assessments that can be levied against the members to ensure proper funding. Regular assessments (often referred to by homeowners as "dues") are based upon the adopted budget each year, although each member's responsibility for the regular assessments can vary based upon the governing documents. For example, in many condominiums the regular assessment rate is premised upon each unit's assigned percentage of value. Alternatively, some governing documents establish equal assessment major repairs and replacement of association assets, insure the common areas in accordance with statutory and CC&R requirements, and enforce the governing documents. Therefore, the board must adopt a budget and set regular assessments at a level to meet these requirements. Furthermore, California Civil Code stipulates boards have a duty to impose regular and special assessments sufficient to carry out their duties under the governing documents (Civil Code §5600(a)).
Despite good budget planning, budget shortfalls or other unanticipated expenses are unavoidable at times. These can come from many sources ranging from economic conditions to new regulations. These are the items that “emergency” and “special” assessments are intended. The other intended use of special assessments is for capital improvements and special enhancement projects. For special assessments, a vote of the membership will be needed, unless the amount is 5% or less of the total annual budget. These other assessments should be used sparingly for the intended uses, not to balance a budget in any one year, which would result in an ineffective annual budget over time.
FINANCIAL STATEMENTS
A well-executed budget is only as good as how well it is used to monitor actual performance during the year. This includes both for the reserve fund and operations. A budget is intended to be used as a roadmap, not train tracks. There will be variances and necessary detours from time to time. So, identify these during the year as trends develop through the year-to-date performance and adjust as you go. This does not mean changing the budget except in the most extreme cases, but it does mean identifying significant positive and negative variances, so the board can actively determine how the positive variance will be used or applied to future budgets and negative variances will be dimished through cost controls or adjustments to discretionary expenses and projects.
Finally, keeping the historical budget information as well as the year-end income statement compared to budget for each year on rolling five-year basis will provide wonderful perspective as you prepare each following budget. Use your prior experience with commentary to develop your budgeting skills.
Keith L Lavery, PCAM®, CMCA®, CCAM® is the Executive Vice President and Chief Financial Officer for Associa Desert Resort Management. Keith can be reached at: (760) 346-1161 or by email to klavery@drminternet.com.
