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Budgeting

Budgeting

Once again it is everyone’s favorite time of year… budget preparation time.  The purpose of this article is to provide a brief overview of the most common budgeting approaches.

A budget is more than just revenue and expenses balanced to a net zero.  A budget should be viewed as an Association’s operating plan for the upcoming year.  There are two basic approaches to creating a budget – zero based and historical.  With a historical approach, expenses are budgeted based on the last few years of actual expenses.  With a zero based approach, the expenses are budgeted based on factual information calculated from scratch annually.

To begin, separate the budget into categories and work on one line item at a time.  This will make the budget process easier to manage.  Below are some of the most common categories with specific details and budgeting approaches on each:

Revenue

What to include: Member assessments, fees for common area use (e.g. cabana rental), move-in/out fees, interest income (be cautious not to use interest on reserve funds to offset operating expenses), sale of access devices, and other potential sources of revenue;

 

Approach: Top down or bottom up?  Most Community Associations, as non-profit entities, generally take the bottom up approach.   Revenue (e.g. member assessments) derives from expenses the Association will need to cover in the upcoming fiscal year.  Often times, the expenses are trimmed and/or services are eliminated to minimize the necessary increases in member assessments.

Professional Services

What to include: Management service, accounting, tax preparation, audit, legal fees, reserve study, etc;

Approach: A mix of zero based and historical.  Use zero based for recurring contracted services such as management, accounting and reserve study.  Base the budget on the value of the contract, check with the service providers to see if they will be increasing their rates next year and update the budget accordingly.  For non-recurring services such as legal fees, use a historical approach.  Checking the last two to three years of legal expenses will provide an idea of how much the Association relies on its legal counsel.  Take into account “special needs” that the Board knows the Association will require next year such as a Declaration Amendment.

Personnel Expenses

What to include: Gross payroll, payroll taxes, bonuses, benefits, recruiting expenses, staff education, etc.

Approach: Zero based for the most part.  Calculate the budget based on pay rates from employment agreements between the Association and staff.  Take into account projected pay increases for next year, bonuses, benefits, etc. Be sure to include a budget for extra coverage when staff members take paid vacations.

Administrative Expenses

What to include: Copies, postage, etc., fees and licenses, taxes (income and property taxes), insurance, loan interest expenses, Board education, etc.

Approach: A mix of zero based and historical.  Use a zero based approach with fees, licenses, permits, insurance, loan interest, etc.  Check with your insurance provider to determine the Association’s insurance needs and the premium cost for next year.  If the Association has a loan, confirm the amortization schedule and work with the Association’s CPA to estimate next year’s income tax obligations.  Use a historical approach for other miscellaneous administrative expenses such as copies, postage, Board education (attendance at CAI seminars/events), etc.

Utility Expenses

What to include: Utilities paid by the Association – water/sewer, garbage, recycling, electricity, natural gas, etc.

Approach: Historical for the most part.  Check the Association’s utility consumption for the past two to three years.  Look for unusual changes in consumption (a sudden increase in water usage may indicate a hidden leak somewhere on the property).  Use a zero based approach for items such as telephone lines and sewer capacity charges.  Use a zero based approach for garbage as well – review/assess the Association’s refuse removal needs, determine the size of the containers and frequency of pickups and budget in accordance with utility company’s rates to meet the refuse removal needs.

Maintenance Expenses

What to include: All property maintenance expenses.  It is generally a good idea to separate expenses by type – landscaping, elevator, fire safety systems, janitorial, etc. 

Approach: A mix of zero based and historical.  Use a zero based approach for recurring contracted maintenance.  Review contracts for each provider (elevator, fire systems maintenance, etc.) to determine the monthly cost of service and create the budget after first checking with vendors for next year’s increase.  For routine day-to-day maintenance (light bulb replacement, touch up painting, etc.) review actual expenses for the last few years, account for inflation and budget extra for special projects if planned.  It also helps to better track expenses if they are split up between “recurring contracted services” and “incidentals”.  Using landscape maintenance as an example, landscape related expenses would be separated into two separate budget line items – “Landscape Contract” and “Additional Landscape Maintenance”.  If the Association’s financials follow the budget and there is a question on “landscaping expenses”, it is much easier to see if the issue is with contracted monthly maintenance or if a significant amount of additional non-recurring work is being performed (replacement of dead plants, broken sprinkler heads, etc.).  Splitting up expenses between “contracted” and “additional” also helps during the budgeting process.  Contracted expenses such as an elevator maintenance agreement are generally mandatory.  Things like additional landscaping work (i.e. annual summer flower plantings) are “negotiable”.  One could decrease the frequency of such service or eliminate it altogether if the Association is unable to meet its financial needs.

Reserves – A reserve study should be used as a tool to budget for monthly funding of reserve contributions, and for forecasting major projects for next year and their associated reserve expenses.  Separating contributions to reserves and reserve expenses from day-to-day operating expenses will provide a better picture of the true financial needs of the Association.

There are a few additional things to consider while preparing a budget.  Bad Debt – many Associations struggle with high delinquency rates due to the state of the economy.  It is important to include a provision for bad debt write-offs as there is a high possibility that an Association will write-off some portion of uncollected assessments, especially due to the current high foreclosure rate.  Associations have several options to pursue owners for unpaid assessments after foreclosure, however if the prior owners do not have assets and/or verifiable income to garnish the Association may struggle to collect on the debt while continuing to incur legal fees to pursue the collection effort.

Contingencies – Always try to include a contingency in the budget.  The level varies depending on each Association’s financial situation, however a contingency equal to 10% of the annual budget is advisable.  A contingency will also assist in better management of annual increases in the Association’s assessments.  If other costs drastically increase, the Association can temporarily reduce the contingency and then increase it back to the original level over time.

Monthly vs. Annual budget – A budget written by month provides better tracking of an Association’s revenue and expenses throughout the year because some expenses are incurred once annually.  For ease of calculation, let’s assume the projected cost of an Association’s audit is $1,200 and it is scheduled to be completed in March.  Budgeting $1,200 in March is much more accurate than budgeting $100 per month for January through December.

A note on expense allocations – many governing documents, especially mixed-use developments with commercial and residential units, include provisions as to which units pay for specific expenses.  This important part of a budget is often overlooked.

Budget approval – there are two basic approaches to budget approval depending on whether the Association is an “Old Act Condominium” (pre-1990), “New Act Condominium” (created after July 1, 1990), or a Homeowner’s Association.  The Association’s Declaration will provide specific guidance on the budget approval process, however typically the Board of Directors approves the budget in “Old Act Condominiums”.  “New Act Condominiums” and Homeowner’s Associations generally follow a budget ratification process – the Board of Directors approves the budget and holds a budget ratification meeting with the general membership.  At that meeting, unless the majority (or any larger percentage specified in the governing documents) of the Association members reject the budget, whether or not quorum is present, it becomes effective as approved by the Board of Directors.

Hopefully by the time this article comes out everyone will have at least a draft of next year’s budget ready and will find this article useful in preparing a final version for the Board of Directors to review and approve.

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September 23, 2010 - Posted by | Accounting, Budget, Planning

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