Understanding how to interpret your HOA management company’s financials are an important part of your role in an HOA. The management company you’re working with keeps detailed financial records and HOA members’ ability to read and understand them will be key in maintaining community funds. This skill set is even more important if you are a self-managed community. We’ve compiled important basics to help ensure you’re following best practices when it comes to managing your community finances in an HOA Board.
There are some keywords that you should familiarize yourself with so that you are able to communicate effectively with the management company and other board members.
- Equity – Equity is a paper concept; equity is a term used to represent the monetary value of a business. It is not how much a business can spend or how much a business has. It can be represented on a balance sheet as either retained earnings or losses, it can also be represented as a current year income or loss.
- Assets – Assets are the cash in a business’s bank account including all of its investments, checking/operating funds, reserve account balance, and any investments. Assets are the positives of a business.
- Liabilities – Unlike assets, liabilities are the negatives of a business, or in other words, monies that a business owes. Liabilities include funds that are unpaid bills due to other people or businesses and money that owners have paid but are not yet owed like assessments.
Positive vs. Negative Equity
There are two different types of equity and it’s necessary to understand what type you’re dealing with in regards to HOA funds. If an HOA has more savings, cash, and funds that are being collected than expenses that need to be paid, it has positive equity. However, if a community owes more money than it’s bringing in, it has negative equity.
When reviewing a balance sheet, you must first make sure that all of the assets are equal to the liabilities and equity. If they are equal, the finances are balanced.
Next, identify whether or not the business has positive equity. An HOA board should not be spending any more than it’s receiving in income. In the case of liabilities being greater than the assets, the business must consider increasing dues or determining a special assessment so it doesn’t deplete all the reserves. If there is a negative equity balance on your finances, consult with your management company community manager. Investigate if and what expenses are greater than the income and then determine the necessary action that is best for the HOA.
A budget is formulated through a standard cost; cost is multiplied by estimates for the coming year to determine a total cost for labor and services. Budgets are used to identify the cost of services under reasonable conditions. Having accurate records of costs is necessary to determine whether or not the services are out of line and if so, where.
Standard costing is essentially used to control costs in assisting community managers. Comparing the budgeted costs or standard costs to the number of costs that are recorded is called “budgeted versus actual”, or “standard versus actual.” Because budgets vary from year to year depending on planned community projects, activities, and reserves, this process can be evaluated regularly.
Maintaining an HOA budget allows a board to closely control the financial operations within a community. To help minimize unexpected expenses, budgets use baselines and clearly define owner assessments. The budget also allows for continuity of maintaining the community’s quality and services. At the end of the day, the budget is essential in providing opportunities for the community to balance its needs and wants.
Some communities may operate with reserve funds and/or active investments, but all financial reports should be reviewed on a quarterly basis by paying special attention to details. An HOA board may also request to review interim reports to determine the proper allocation of funds and financial balance. Preparing budgets for the next year should be done several months prior to the new fiscal year and it is recommended that proposed budgets should be approved at least 45 days prior to the beginning of the budget or fiscal year.
Working with your HOA management company, you can determine the correct choices as they pertain to your community and allocations within your budget.
HOA Reserve Funds
Reserve funds are community associations funds for a ‘rainy day’ meaning they are kept for unforeseen circumstances. The fiscal health of your HOA is determined by calculating the balance of that fund by doing a reserve study.
Before moving into a new community overseen by an HOA, you’ll want to determine their financial health. And if you’re already living within an HOA community, you should be familiar with the last time a capital reserve study was conducted. These studies should be done every few years. A reserve study is used to verify the strength of all common areas that fall under the responsibility of the HOA. These items would include things like the courtyard, swimming pool, community center, elevators, and roofs. The results of this study should provide an estimate of any necessary future maintenance or repairs.
A reserve study can predict the funds that will be needed on hand to address the maintenance issues or repairs that are identified. For example, if your community-center roof has a twenty-year life and it’s only been 1 year, you would be funded 100% if the cost of its replacement to the value of 1/20th is in the reserves for roof expenses. However, this process needs to be completed for each of the components. If you complete this process for each of the components that fall under the responsibility of the HOA and have all of the necessary funding, then you are considered to be 100% funded.
This is, in summary, the purpose of the reserve study. Adhering to this process can ensure an equitable relationship between the future owners of the HOA and current ones in regard to financial obligations. You may already be paying into a reserve fund as part of your homeowner dues. The ideal scenario is to be as close to 100% funded as possible. Reserve funds that operate near 70% are in good shape, but if your community is falling closer to 50% or below, you should be concerned. If a project comes up that is necessary for the completion and the reserve funds are not able to cover the cost, homeowners are potentially charged with huge assessments. While lower HOA fees may seem more attractive for an HOA, they’ll unlikely be able to compensate for a reserve fund appropriately and could be an indication of a flawed HOA management strategy. It’s better to not aggravate homeowners with assessments and focus on proper budgeting techniques.
In addition, inadequate funds may lead to difficulty in the ability to sell homes within your community. The Federal Housing Authority, also known as FHA, will limit loan assistance to communities with lower reserve funds. This creates complications for current owners trying to sell their homes.
HOA communities should seek to find a balance between monthly homeowner dues and appropriate contributions to the reserve funds. Your HOA management company can assist you in finding a professional engineering company to complete a reserve study in your community. If you are self-managed, there are quality reserve study companies in your area that could provide the service. As always, we recommend getting multiple bids.
If you learn and follow these best practices, you will be on your way to running a financially sound community. Sign up for Boardline Academy to learn more about managing HOA finances in your community.