While it is always important to know where your community stands financially, it is especially important to understand the community’s financial status in an economy riddled with increasing expenses, higher delinquencies, and more bad debt write-offs. Following are several recommendations and standards for analyzing a community’s financial health:
Recommendation A: 2-3 months of expenses in your operating account(s) (liquid funds) at all times.
For example, if your community has a budget of $20,000 per month for operating expenses, we would recommend that you have between $40,000 and $60,000 in an operating fund savings account. Doing so helps to ensure that the association can cover monthly expenses plus any unbudgeted expense that may arise, even factoring in assessments that are delinquent and not received. Boards should keep this in mind when considering investment opportunities. Only funds in excess of two – three months of operating expenses should be considered for longer-term investments that commit the funds for months or years.
Recommendation B: Investments reflect the reserve fund balance
Industry standard (and in some cases state law) encourages (or requires) communities to set aside part of the maintenance fees in reserve funds, and further recommends (requires) that a community segregate operating funds and reserve funds. Reserve funds should be invested in safe monetary vehicles like CDs and insured money market accounts. The total amount in those accounts should be the same amount that’s listed on the balance sheet for the reserve fund.
Recommendation C: Reserves funded in accordance with the reserve study.
Not only is it important to support the reserve fund balance with actual cash in the reserve investment account(s), it is also important to review the reserve balance as it compares to the amount recommended by the association’s reserve study. Special attention should be paid to this during budget preparation time. Rather than simply plugging in the recommended annual contribution number, an analysis should be done to determine the current projected year-end reserve balance and whether an adjustment to next year’s reserve contribution is warranted. For example, if the reserve study recommends a balance of $400,000 in the reserve funds at the end of fiscal year 2010 and it is determined that the actual balance at the end of FY 2010 is projected to be $300,000, a multi-year plan needs to be established to increase the reserve contribution to make up the $100,000 deficit. In some states, an annual or regular reserve study update is required; a comparison between actual and forecasted balances would be completed during that review. Similarly, if there are more funds in the reserve account than the reserve study recommends and all the recommended capital replacement projects have been performed, the reserve contribution could be decreased.
Recommendation D: 10-20% of the total annual assessment amount in is reflected in Prior Year Equity (this is a recommendation that auditors make so that the association has a “cushion” in the event of a major unanticipated event).
Prior Year Equity, which auditors frequently refer to as Unappropriated Members Equity or just Members Equity, is the accumulated operating deficit or surplus from the association’s inception. While the developer is funding the operating deficit, the Prior Year Equity balance is usually $0. Once the developer is no longer funding the deficit and the association is self-sustaining, the association should work to achieve the 10-20% Prior Year Equity level. For example, if your community has budgeted $300,000 for the total annual assessment income, auditors recommend that the amount accumulated in Prior Year Equity be between $30,000 and $60,000. Any amount lower than $30,000 would be noted by auditors as insufficient and any amount over $60,000 would be noted as excessive. The auditors feel that this gives the association excess funds to cover a major unanticipated event not covered by insurance, such as plumbing lines that develop pinhole leaks, that would lead to a substantial operating deficit. The result could be not having adequate funds to replace or coat the plumbing lines. So, what happens if you aren’t adequately funded in Prior Year Equity? In future years’ budgets, the association should consider budgeting for an Operating Contingency (funds not earmarked for any specific expense) or should consider creating a line item specifically to fund Prior Year Equity in order to bring the balance into the 10-20% range.
Recommendation E: Delinquency rate does not exceed 3-5% of the total annual assessment income.
Using the example above with a community that has budgeted $300,000 for the total annual assessment income, the total delinquent assessment amount should be less than $15,000 to be financially healthy. It is important that associations do everything possible to aggressively pursue collection of delinquent accounts, in accordance with applicable federal and state law, the association’s governing documents, and established collection policy. It is also important that the association, in accordance with the collections attorney, periodically review delinquent accounts and decide to write off accounts that are not collectible or where further collection effort is not cost-effective for the association, after the mortgage company foreclosed on the home. Many boards hesitate to write off uncollectible accounts, but often it is the wisest decision for the board to make.