Introduction to Financial Management

A budget establishes what services the community will provide, as well as when and how they will be done. In other words, a budget reflects the board’s policy decisions about what will be accomplished and what will not be accomplished during the budget period. Utilizing the budget as a management tool, it has many uses:
  • A way for the community to plan activities
  • The basis for determining owner assessments
  • Along with financial reports, it is a means of controlling the community’s financial operations
  • Provides for continuity of community services
  • Helps the community maintain its desired quality of life
  • Helps limit surprises and minimize the unexpected
  • Provides an opportunity for a community to balance its needs and desires
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Sources of Budget Requirements

Budget items will vary from one community association to another. They also will vary from year-to-year for the same association. Many budget items develop in the normal course of doing business and the fluctuating size of an association over time. However, a number of budget items appear because they are required for four governing levels:

Federal Laws and Regulations

Federal laws and regulations can lead to community expense items.
  • For example, all community associations must conform to IRS requirements regarding income and payroll taxes.
Federal agencies may also establish expense requirements that your community has to meet.
  • For example, in the environmental area, you may have to budget for hazardous waste disposal.
Federally established secondary mortgage institutions such as Fannie Mae, Freddie Mac, FHA or VA may also set requirements that your community association will have to meet if owners are to participate in their financing or repurchase programs.

State Statutes Regulations and Court Decisions

All states have statutes that enable the establishment of condominiums, corporations, and/or planned communities. In several states, these statutes require or regulate such community association budget items as replacement reserves, audits, state taxes and fees, insurance, and the conduct of financial operations. What a specific state statute says very often will override what your community’s governing documents say. Check the state statute’s wording carefully to determine its applicability to your association.

Local Laws and Regulations

Your local government may have codes, laws, and possibly taxes with which your community association must comply. Any requirements in these areas will result in expense items for your community’s budget.
  • For example, your local fire code may require such items as sprinkler systems, exit signs, fire extinguishers, or elevator inspections.
Your local health and safety codes may require pool inspections, water quality tests, or mandatory procedures for sewage disposal or recycling. Property taxes may or may not be levied on land commonly owned by the community association, depending on your state or local jurisdiction.

Community Governing Documents

The governing documents of your community define the property to be maintained by the association, and specifies maintenance and service responsibilities and requirements. These maintenance and service items will appear in the expenses section of your community’s budget.

Basic Budget Components

Like most budgets, the two main components of a budget are simply revenue and expenses. However, what these two items consist of with regards to a community association such as an HOA can be finite, and it's important to understand what each includes. Scroll over the below images to get a better idea of each individual component.

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  • 1. Owner Assessments - An assessment is the owner’s financial obligation to the community association during a given period of time (usually one year). It covers the owner’s share of the common expense. An annual assessment may be paid on a monthly, quarterly, or annual basis, or however the governing documents dictate. Most of a community’s revenue will come from owner assessments. Occasionally, special assessments may be levied. A special assessment is a one-time assessment often voted on by the owners to cover a major expense that was not included in the annual budget or replacement reserve.
  •  2. Interest -  A typical source of revenue for communities is interest of dividends earned on their cash savings and investments
  •  3. Other Revenue - Other sources of revenue include late payment fees, fines, user fees (i.e. parking space rentals, move-in/move-out fees, etc.), clubhouse rental fees, collection or insurance claims, legal settlements, or easements.
Revenue
Revenue consists of the collective items or amounts of income which, in the case of a community association, are appropriated for common expenses. There are three typical sources of revenue for a community association.
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  •  1. Operating Expenses -  Occur on a regular basis for the normal and usual services and repairs for the association such as: Swimming pool management,  Professional and administrative services (management, legal, insurance), Utilities (electric, gas, water), Contract services (lawn maintenance, elevator, trash removal), Repairs (plumbing, electrical, doors/locks), Personnel costs (compensation and benefits for community employees), Educational costs for employees, board members and volunteers (memberships, courses, and publications from Community Associations Institute).
  • 2. Major Improvement Expenses - Consist of items that are not necessarily required, but are added to improve the quality of life for the residents, appearance of the property, or to enhance the value of the community association as reflected in the resale value of units. A major improvement expense this year becomes a reserve item in the following and future years. Maintenance, repair, or replacement. They increase the life, usefulness or value of a property. They are called major improvements because they last more than one year and involve a large amount of funding.
  • 3. Reserve Account - The establishment of a reserve account is a community association expense that requires detailed explanation.
Expenses
Expenses consist of the cost of goods and services used to operate and maintain the association’s common elements. Typically there are three types of expenses for community associations.

Roles and RESPONSIBILITIES

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Board of Directors

Most board of directors are responsible for establishing, approving, and monitoring the community’s budget. Although they have the power to establish a budget, most will delegate preparation authority to their manager. When the board of directors for any community association reviews a proposed budget, they should consider the following:

> Legal requirements of state statutes and governing documents > Owners needs and desires (balancing mandatory and discretionary items) > Committee and owner feedback > Reconcile revenue and expenses > Financial forecasts and analysis of past financial activity prepared by the manager

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Treasurers

The community treasurer is responsible for ensuring the draft budget is prepared and approved. usually initial preparation of the budget is done by a manager, and treasurers work with them to get the budget approved. The treasurer may review the draft budget with a finance committee if available. If the association has a finance committee, it is important that the treasurer consult all committee chairpersons and invite owner input to ensure their support. Their participation and support would be especially important where a vote of owners is required or recommended for:

> Increase in assessments > Special assessments > Major improvements > Funding replacement reserves

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Manager

The manager is typically responsible for preparing the draft budget, reviewing the draft budget with the board, revising it after any changes are made, and providing a summary of the budget to the owners after board approval (unless stated otherwise in your governing documents or state statute).

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Owners

Some states and some community governing documents require that the budget be passed by a vote of the owners. The preceding discussion explains when and why owners should be involved in reviewing the proposed budget - even when the board is responsible for its adoption.

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Budget Components - Preparation

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Development of Budget Line Items

Each line item in a budget represents a different account or category of revenue or expense. There are two types of expenditures in a community budget:

  • Mandatory Line Items - Community and owner needs and obligations (taxes, repairs, utilities, maintenance, etc.)
  • Discretionary Line Items - Owner, board and committee desiers or expectations (social and recreational expenses, picnic areas, patrols, pool towels, etc.)

When preparing your draft budget, list your line items in as much detail as possible to help you assign costs. For example, utility line items may include: water irrigation, water-sewer, electricity, streetlights, natural gas, garbage, telephone, cable TV, etc. 

Budgeting By Month

One of the best financial management tools for both the manager and the board members is the Statement of Revenue and Expenses, that, among other data compares actual expenditures and revenue sources to budgeted amounts in each category. Thoughtful and deliberate calculation of each budget line item is important. When you compare actual figures with budgeted figures, you can:

  • Identify all significant differences or variances between actual and planned figures
  • Determine the reasons for the differences
  • Executive any corrective action that may be needed as soon as possible
  • On accrual basis reports, the budgeted assessment income should equal the actual assessment income
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Two Basic Budgeting Methods

  • Zero-Based Budgeting - All Line Items are set to zero and the amount of funds allotted to each must be justified.
  • Historical Trend Budgeting - This method begins with the assumption that existing line items are needed. The amount of funds allotted to each during the current year is adjusted for expected changing in the coming year. sources of historical information include financial reports, existing contracts, and bills from the past year.
 

Traditional 

Zero Based 

Meaning

It’s computed by keeping the
starting point at zero
It’s computed by keeping the
previous year’s budget as base

Preparation

Simple Complex

Emphasis

Expenditure of previous year Each item is considered as per
the new economic appraisal

Approach

Based on historical information Based on estimated information

Cost Effective

Doesn’t encourage cost
effectiveness
The purpose is ensuring cost
effectiveness

Prefers

All departments Only profit centers

Effectiveness

Effectiveness depends on the
individuals who did the previous
year’s budgeting
Effectiveness depends on the
current top management of the
company

Linked To

Assumptions of the previous year Estimations of which department
can bring more profits

Clarity

Almost none High

Orientation

Orientation revolves around
accounting
Orientation sits around project/
decision unit
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RealManage Can Help!

Whether it's for personal use or for your entire community association, financial planning is a complicated but vitally important process. If your association is interested in finding out more about how RealManage can help your community plan for the future, please reach out to us today! 

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