The Importance of Financial Stability in Community Associations
One of the main components of the administration of a Community Association is ensuring the community stays on firm financial footing. This is vital not only to the success of the Community Association and its future but helps to increase owner satisfaction and property values in the community. When a well-developed budget is created and adhered to by the community, the process of maintaining firm financial footing becomes much less cumbersome.
Key Differences in Community Association Budgeting
When talking about a budget for a Community Association, it differs greatly from a budget one would make for themselves and their personal expenses. Some of those differences include: maintaining fiduciary duty, analyzing historical trends, planning for future expenses, maintaining reserves as required by state statutes, working with experts for long-range plans and expenses, and ensuring the community is trending to exceed recommendations.
Understanding Fiduciary Duty
What is fiduciary duty? In the basic sense, it is, working in the best financial interest of the entity being represented. In the scope of Community Associations, it relates directly to the Board of Directors elected to represent the community. “Board Members are bound by federal, state, and local statues to act within their authority, to exercise due care, and to act in good faith and with ordinary care that they believe to be in the best interests of the Association”. Meaning that the Board of Directors must always put the Association’s best interests above their individual beliefs and opinions and act accordingly.
Preparing for Budget Creation
Before the budget creation process is started, the Association should be aware of any contracts in place for the year that a budget is being created for as well as any contracts that will lapse prior to or during that year. Contracts for items like: lawn maintenance, snow removal, management services, utilities, pool maintenance, etc. Should be looked at closely to determine if they will be in force and what the cost will be, as outlined in those contracts, for the budget year that is being created. Late summer is a great time to start bidding out contracts or getting estimates for the following year for contracted services. This timeline will allow the Association to have accurate numbers for contracted services when the budget in finalized in the fall (typically).
Building a Solid Budget
When it comes to budget creation, there are many ways to create a solidly built, accurate, and stable budget. In order to do this, heavy analysis of the community’s finances is required and usually completed by the Association’s management company, CPA, or finance committee. The most commonly used method of budget creation is, Historical Trend. With this method, a lot of emphasis is placed on what has worked well in the community’s past and what could be improved upon. A budget created with this method looks at what was budgeted in prior years and compares it to what was spend in prior years. An analysis can then be completed to determine if there were variances from budget to actual, why variances occurred, and when/if those variances could occur again. This analysis can then build a basic budget for those items that are contracted, recurring, scheduled, etc.
Planning for Future Expenses
After the basics of the budget are created for the general operation of the community, a heavy focus should be placed on planning for future expenses whether it be setting aside money in the budget to save for them or budgeting to spend money in that year to maintain common elements in the community. A tremendous resource that can be used to assist with this process is a Reserve Study completed by a third-party professional expert. This reserve study will help outline upcoming large expenditures the community will face. Reserve Studies will outline when the Association can anticipate a large expense as well as how much it is anticipated to cost. These two pieces of information can then be incorporated in the budget so long-range expenditures can be planned for well in advance, reducing the possibility of large assessments, increasing dues exponentially, or being forced to obtain financing.
Building Reserves for Stability
The next component of building a budget is the reserve/savings aspect of it. In Michigan there is a state law requiring that “The co-owners’ association shall maintain a reserve fund which, at a minimum, shall be equal to 10% of the association’s current annual budget on a noncumulative basis.”. Some governing documents may require more than 10% to be placed into reserve as well. A community must always adhere to state laws regarding funding reserves in order for the Board of Directors to remain compliant with their fiduciary duties to the community. However, many experts recommend saving well more than the minimum required by the state. This is another area where a reserve study could be exceptionally useful in making proper future projections relating to expenditures. Often times, setting aside 10% of the budget each year will not save enough money for large capital projects like road and roof replacement by the time they are needed.
Adding Discretionary Line Items
After a budget is drafted to include all of these components listed above, discretionary line items can then be added based on feedback from the owners, committees, and Board Members. These budgeted items can include items like aesthetic improvements, special services in the community, or upgrading common elements in the community (as long as the community’s governing documents permit it).
Balancing Income and Expenses
Now that all expenses are created, the income side of the budget can be calculated. It’s always a great idea to determine the fixed and desired expenses and then work backwards from there to determine the funds needed to achieve these items. If a budget is built in the opposite direction (starting with income), often times the budget will be underfunded or budgeted items will need to be reduced or eliminated; which can be detrimental to the community. If a budget is underfunded or expenses are removed from the budget it will lead to common elements not being maintained, additional funding being required, and increased owner dissatisfaction.
The Importance of Strict Budget Adherence
After a complete and accurate budget is put together and approved, it is just as important as the budget creation process to ensure the budget is strictly adhered to. There should be contingency funds and budgeted items for special or emergency situations that come up so if something does occur, it does not invalidate the entire budget. The budget and variance to it should be routinely reviewed throughout the year to ensure the community is on track to come in at or under budget and make course corrections on spending as necessary.
A Path to Financial Stability and Owner Satisfaction
When proper planning and execution of a budget is in place in your community, the headaches relating to finances are greatly reduced for the Board of Directors and the community as whole. They community will also have an increased probability of remaining on firm financial footing, and increasing property values as well as owner satisfaction in the community.
By: Lee Powers PCAM | C MCA | AMS, COO, KS Management, Inc.
Originally published in CAI Magazine MI Chapter Third Quarter 2021
