Expert Tips for Effective HOA Financial Management

Homeowner Associations are unique entities. In some ways, they are akin to small cities that manage community assets, fund operating expenses, and impose dues and assessments. However, unlike municipalities, volunteer boards of directors oversee HOAs, while most municipalities employ a staff of paid experts and consultants.

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Many HOA board members need more background and training to understand the unique nature of HOA finances. Unfortunately, HOA board training options are limited. Hence, board members must learn on the job, which can become tricky given the volunteer nature of the role.

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At a high level, there are a few essential buckets of vital financial information and reports that HOA Board members should be familiar with and they fall into.

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Operating Income and Expenses

1. Definition: Money generated from regular activities, primarily through homeowner dues and fees, and spent on ongoing costs to maintain the community.
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2. Process: Annual operating budgets are forward-looking and should project income and expenses. The board should establish the annual budget at the beginning of the year. Monthly financial reports should reflect income and expenses and performance vs. budget. A bookkeeper, accountant, property manager, or designated board member should prepare monthly performance metrics throughout the year.
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3. Purpose: Operating budgets account for day-to-day expenditures, such as maintenance, utilities, and administrative costs. Mark Cantey CPA from HOA Financial Solutions says, "The operating budget is the most critical financial document of the organization." He explains, "The operating budget is the basis for legal assessments to unit owners."
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4. Implications: Favorable operating income indicates that the HOA successfully manages its income relative to expenses.

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Balance Sheet

1. Definition: This report lists an association's assets, liabilities, and capital. It is similar to a personal "net worth" statement. Balance sheets provide a snapshot of an association's resources.
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2. Process: Reports should be updated monthly to reflect cash, accounts receivable, and accounts payable changes.
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3. Purpose: Balance sheets provide a snapshot overview of the liquidity and net worth of the association.
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4. Implications: A healthy balance sheet indicates that the HOA can successfully manage its income relative to expenses over an extended period. This snapshot helps assess the resources an Association will have to work with in the future.

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Reserve Accounts (reported on the Balance Sheet)

1. Definition: These are designated funds for future repairs, replacements, or major projects (e.g., roof replacement, pool renovations).
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2. Process: Reserve studies identify and inventory assets owned and maintained by the community. The report also shows their current condition, estimated life, replacement costs, and funding plan. It's a best practice to create an income and expense statement for the Reserve Account. The board should isolate reserve funds and account for them separately from operating funds.

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Determining the correct amount of money to put into Reserve Accounts can be a tricky process. When an association has a material amount of Assets, it is best practice to employ a professional to conduct a Reserve Study. The Reserve Study is used to identify the association's assets, assess their current condition, project their remaining life, and determine the timing and costs of repairs and replacements.

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1. Purpose: The goal is to ensure the HOA has enough money for significant, unexpected expenses without imposing special assessments on homeowners.
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2. Implications: A well-funded reserve account reflects good financial planning and helps maintain property values within the community.

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Fund Balance (reported on the Balance Sheet)

1. Definition: This represents the cumulative profits (or losses) the HOA has accumulated over time, minus any distributions or expenses.
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2. Process: Since this fund balances the association's net worth, it will fluctuate as profits or losses are incurred. When an Association books a net gain or loss for a reporting period, this change is reflected in the Fund Balance account on the Balance Sheet.
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3. Purpose: Fund Balances can be used to fund future projects, cover deficits, or strengthen the HOA's financial stability.
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4. Implications: Strong Fund Balances indicate a healthy financial position, while negative Fund Balances suggest financial challenges.

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All these measures assess the overall financial health of an association. That begs the question of how to define healthy. Each board should set its definition of financial health. Some boards may define healthy as keeping 3- 6 months of operating expenses in Cash. Others may be more comfortable with a 9 - 12 month cushion.

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It's a best practice to consider the level of Reserve Account funding when defining overall financial health. Many Boards want to benchmark their reserve funding as a percent of a fully funded target.

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While funding Reserve Accounts at 100% of a Reserve Study's recommended level, is an admirable goal, this target may not be practical. Boards often deem 50% to 75% of a fully funded reserve target to be adequate.

In summary, operating income focuses on current revenue and expenses, balance sheets indicate net worth, reserve accounts are about planning for future needs, and retained earnings reflect the overall financial health of the HOA over time.

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A basic knowledge of how these financial tools work will help Board members understand an HOA's overall health. Understanding how the reports interlink will help the board responsibly plan for a healthy financial future.