Each New Year brings on new challenges and responsibilities for homeowners association boards of directors. One of the most important annual functions is the adoption of a budget for the association’s projected income and expenses during the next year. Creating a realistic budget is a difficult task for many associations and, as a result, the annual budget is either not created at all, or the most recent last budget is merely copied with a few tweaks here and there. The careless preparation of an association’s new annual budget will ultimately lead to operating problems, the need for the dreaded “special assessments,” and internal conflicts between board members and/or homeowners.
The are many factors that should be considered in the preparation of an annual budget. While the history of past expenses is important to know, it also critical to have a clear understanding of the physical components that make up the association’s common area that must be properly maintained. Such an understanding necessitates knowledge of what the physical components actually consist of, the expected term of each component’s life, the cost of repairs and replacements of that component, and how much time is left before the component must be replaced. In order to properly take all this information into consideration association boards should have an accurate “reserve study.” Reserve studies are reports that are prepared by qualified professionals who inspect the association’s property and provide all of the necessary information that is required to know the extent of funds that are required to be collected from owners each year in order to maintain sufficient reserves for funding the repairs and replacements of the various physical components as they age and begin to deteriorate and break down. Associations that maintain sufficient levels of reserves have less operating problems than those that do not, tend to be better maintained and are generally more valuable on resale. If your association does not have an up-to-date reserve study, bite the bullet and get one prepared.
Aside from knowing the correct amount that should be allocated to an association’s reserve funds, it is critical to know the past history of the association’s expenses to be able to forecast those that are going to reoccur during the next year and the amounts that are necessary to pay them. This information comes from a review of the association’s financial statements. Associations should have complete and accurate financial statements that are prepared by qualified bookkeepers and/or accountants. In fact, state laws frequently impose requirements on associations for the preparation of financial statements and reviews of those statements by licensed accounting firms. The preparation of a current budget should take into account the actual income and expenses realized by the association in the previous two years of operations.
Because expenses change each year as the cost of goods and services go up, it is important to make adjustments to the amounts spent in prior years for the known increases that are going to be required for monthly services, annual maintenance and other known projects or events that are going to require funds. These expected additional amounts should be factored into the budget for the New Year.
Another area of expenses that homeowners associations frequently have difficulty with accurately projecting is legal expenses. While the cost of prosecuting and defending legal actions is rarely a constant that can be accurately predicted from year to year, a realistic amount that is based on prior experience and known pending and anticipated matters should be incorporated into an association’s annual budget to avoid having to deal with special assessments to cover those items.
The creation and maintenance of an accurate budget for an association’s annual income and expenses is one of the most important responsibilities of the association’s board of directors. Because directors owe fiduciary duties to the members to keep the association financially stable and to properly maintain the common areas within the common interest community, it is critical that an accurate budget be prepared and utilized to determine the proper amount that is necessary for the association’s annual assessments to be paid by each member. The budget should then be circulated to all association members so that they too understand their association’s finances and the need for the amounts that they are required to pay in periodic and/or special assessments. While association members hate to see increases in their annual assessments, they would much prefer to pay slight annual increases with each periodic payment they make (i.e. monthly or quarterly payments) to large special assessments that are required because appropriate amounts were not budgeted for.
If your association has not been diligent in the past about preparing an annual budget, now is the time to get on track. Start the New Year off by resolving that this will be the year to improve upon past improper or poor financial practices that will ultimately be damaging to your association.