Financial Foundation: Getting Started with HOA Budget Basics

A community association budget estimates revenue and expenses for (at least) generally one 12-month period called a fiscal year. It’s the foundation of a community’s financial management and operation. It’s a tool flexible enough to accommodate adjustments mid-year and still achieve its purpose.

WHAT IS A BUDGET?

• A financial planning tool — an estimate of next year’s expenses and revenues
• A foundation for establishing the annual assessment
• A defense against special assessments, reduced or inconsistent services, or deteriorating property
• A tool for measuring and monitoring the association’s financial activity
• A notification to homeowners how their money will be used
• A snapshot of annual financial activity useful for comparison in subsequent years
• A tool to measure the board’s performance as fiduciaries
• A path to future financial stability

A new budget — or an update of the previous budget — must be developed each year because different conditions exist each year:

• Maintenance needs may increase or decrease
• Utility costs may fluctuate
• Energy-efficient improvements may lower power consumption
• Reserve contributions may need adjusting
• New regulations may force changes to community operations

If the association develops long-term budgets — two to five years out — each will need to be carefully evaluated and adjusted annually.

WHY ARE BUDGETS IMPORTANT?

• Many state statutes, and most governing documents, require boards to exercise their fiduciary responsibility to the association members. That imposes a legal obligation to develop as accurate a budget as possible and collect sufficient assessments to cover common expenses.
• Budgets lay out the board’s plans to maintain and improve the community. Generally, those plans take into consideration residents’ preferences, community aesthetics, meeting legal requirements, and other factors.
• Budgets are oversight tools that provide a way to gauge spending and to identify financial inconsistencies and anomalies.
• Budgets are references for good decision-making because they’re based on a deliberative process, careful planning, and the advice of experts.
• Well-prepared budgets alleviate homeowners’ concerns about financial surprises, uncertainty, and special assessments.
• A well-annotated and detailed budget helps residents’ understand why their assessment amount is reasonable and accept that it’s necessary.

HOW ARE BUDGETS STRUCTURED?

At the simplest level, budgets enumerate expenses and revenues, but with common interest associations, expenses include operating (unrestricted) funds and reserve (restricted) funds. How “restricted” these funds are will depend on governing documents and state statutes. They generally are not restricted in the true sense of the word.

Operating funds are those used to run the association on a daily basis. Usually, operating budgets are for expenses that occur within one fiscal year.

Operating expenses should be budgeted in the months in which they occur (e.g., snow removal in the winter and increased water use in the summer), but the assessments are uniformly billed during the year.

Reserves cover expenses that will arise in the future that an association must save for now (funds held in reserve). While operating funds can be used as needed, reserve funds generally can only be used for designated purposes. Estimating current operations’ expenses is very different from estimating reserves.

WHAT SHOULD BOARD MEMBERS KNOW?

Developing a budget is a task board members may assign to the association’s professional community manager or accountant. Even so, boards need to understand what they’re doing, how, and why.

The budget development task can be delegated but not the responsibility for the association’s finances. That belongs solely to board members. They have a fiduciary duty to review, monitor, and follow the budget.

>>Find out how to get your HOA budget started, what goes into the operating and reserves budgets, how to balance the budget, and how to present it to homeowners in CAI’s How to Draft a Budget guide.