Practical thoughts on budget preparation

The fact that the residents are also the owners creates unique budgeting issues because there is technically no income in a non-profit organisation. An effective way to properly budget is to understand that even in a period of relatively low inflation, costs do go up. It is reasonable to assume that some elements of cost will go up faster than others.

For example, if interest rates start to creep upward, you can expect electrical costs to rise disproportional to other costs. This is because the utility industry is very sensitive to interest rates, and rising interest rates result in higher electrical costs. Some items that need a more penetrating evaluation include utilities, as mentioned, as well as insurance, maintenance and repairs, and general repairs, particularly for older buildings. Today, because of the tight labour market, it is nearly impossible to hire a repair person for the same hourly rate as just one or two years ago.

It is a disservice to the entire community to create a budget that does not represent the real needs of the community and adjust the cost projections to reflect conditions of the economy. Frequently, the manager is under pressure from the board and community residents to keep the draft budget and the resultant levies unrealistically low. While the board’s and the residents’ desires are honorable, it is not realistic.

Managing the finances of the association is usually the toughest job board members have. Despite the importance of the budget, when it is brought before the board for review, most board members figuratively cover their eyes and only peek out from behind their fingers occasionally. A good community manager can help with economic issues such as interest rate projections and inflation factors. However, it is up to the board to be responsible for such things as the capital reserve study projected needs of the community for this year (surely you have an up-to-date capital reserve study!), community desires and goals (often derived from committee reports or from resident surveys), and revenue projections (what is the ‘pain threshold’ of the residents to a levy increase?).

It is rare for an association to budget for emergencies. Most boards believe that if an emergency does develop, they can use the accumulated capital reserve to cover it. This is not a good strategy. Capital reserves should be set aside to cover major replacements such as roofs or asphalt parking lots.

The argument is often made that insurance will cover emergencies and we (the board) do not have to budget funds for them. This is also a specious argument. Insurance, for example, will not pay for the trees that get knocked down in a storm (it will pay, in some cases, to have the downed trees removed but not replaced). In any event, even in situations where the insurance company does pay, there is always an excess payment. A modest emergency fund should be established and if you’re fortunate enough not to use it in one year, add to it in the next year.

Many budget experts argue that a budget should be for a long term – three to five years. With all the problems in developing a workable budget for one year, it is difficult to imagine the complexities of a multi-year budget. It is not unusual for a contractor to agree to perform a service for the same price as last year, assuming that the manager and the board agree not to compete. However, it is difficult to visualise a contractor agreeing to keep the same price for three or five years. It is also difficult to visualise a management company keeping its monthly fee the same for an extended period.

It is not unusual for a builder/developer to turn over a community project where each unit pays the same monthly levy. This is frequently done because it is easier to sell units and easier to manage them if all the levies are the same. However, if the Declaration shows owners with different shares of ownership, it is patently unfair to about half the community who are paying more than their percentage of ownership.

A resident’s ownership percentage, in a sectional title scheme, is usually determined by the ratio of the square footage in the individual’s unit as a percentage of all the square footage in the community. The ownership percentage is expressed as a percentage, such as 1.234%. This percentage is critical because the resident’s levies should be that percentage times the final annual budget, divided by twelve. In addition, any special levy should be developed the same way. And the final significant issue is that voting at annual meetings should assign each voter the appropriate percentage and count the percentage when tallying the vote. That way a person with 1.234% has more than one vote for their unit.

When, in a free title scheme, a responsible board changes from a flat levy to a pro-rata levy, the community is in a turmoil. Again, about half will be paying more and about half will be paying less. In the long run, the board can avoid those nuisance lawsuits that are so prevalent in this business, by a resident who is paying too much, by making the correction and dealing with the turmoil. Occasionally, a pro-rata share is developed by circumstances other than a percentage of ownership, for example, how close a resident is to a lake or what view they may have. In any event, the basis of the pro rata share is developed, and the fact that the Declaration provides for a pro-rata share is very important.

The beginning of the financial year for a community is the end date for the budget process. A properly prepared milestone schedule begins about three months prior to the beginning of the financial year, with the budget being approved and in place at least one month before the beginning of the financial year. Many financial years, certainly not all, coincide with the beginning of the calendar year, 1 January. This means that to be effective and properly in place, the budget process must begin no later than 1 October.

The start point is historical data and information. The manager should prepare a spreadsheet showing the budget and expenditures from the two previous years. Without the expenditures, the budget alone tells you nothing. Then add to the spreadsheet the budget and expenditures for the current financial year. You won’t have the entire year, so add fixed expenditures that you know about, like management fees, for the remaining months. For other expenses, you can make reasoned judgments about the coming three months.

You now have a pretty good idea of how close to the target you’ve been in the recent past. Analyze those expenditures that deviate substantially from the budget and try to understand the difference. Was the estimate just plain wrong, no one’s fault? This is the most common reason but the one most feared. Boards like to blame the manager and the manager argues that they are not clairvoyant. Forget this exercise in futility. It will not solve anything. Fix it in the new budget.

Income should be based on levies only. It is futile to try to budget for interest income and late fees. Most budgets show both interest income and late fees, but to what purpose? It may make some board members believe they have more money coming in than they really do, and this will give the board member a false sense of security. In addition, some management companies take the approach that the late fees belong to the management company because they are compensated for their extra work and do not impact the entire association. It doesn’t matter what your position is – putting this potential income in the budget is not useful.

Begin the budget process by accumulating expenses in four categories: Administrative, Utilities, General Maintenance, and Capital Reserve. Not everyone will agree with these categories and the manager should respond to the preferences of the board. Not everyone will agree with the subcategories either, but the key to success will be not to leave anything out.

Some boards want a budget with major categories such as grounds maintenance, which would include lawn service. Other boards want many subcategories such as lawn cutting, lawn edging, blowing clippings, shrub edging, shrub trimming and so forth – you get the idea. The key point is that the budget format must satisfy the board. The manager, however, had best break down the categories into as much detail as possible, and save the detail so that they can substantiate for the board where they got their numbers from.

At all times, as the next step takes place, the manager must take into consideration the factors described previously: the results of a capital reserve study, the needs and goals of the development, and the age of the buildings. If the entire community is complaining about no mulch around the beds and trees, and that the grass is filling up the beds and circles around the trees, for heaven’s sake, budget to mulch the community. The fact that five years ago the mulch had some ugly ‘creepy-crawlies’ with it is no excuse for not adding mulch. Just attack the problem of keeping the insects out but add the mulch. Certainly, budget for it.

If an association does not have a capital reserve study done by a professional company that specialises in community capital reserve studies, either it is a relatively new community, less than five years old, or the manager and/or the board are not doing their jobs properly. How can you run a major corporation, and that is what a community is, without a plan? The answer is you can’t! It’s just that simple. Assuming you have a study done, refer to it and see what it recommends for the budget year you are working on. It may just suggest the accumulation of certain funds or it may call for certain work to be done. In any event, add this to the budget.

The fun begins when you start allocating funds to each of the accounts you have established. Have a cogent reason for each amount you decide to put in the budget, making the same kind of evaluations as discussed above, especially anticipated increases. That’s where the arguments will be. The board rightfully has the obligation to be comfortable with each projected expense and challenge anything it is not clear on or disagrees with. After presenting their rationale, the manager backs off and adopts whatever the board decides. The manager’s ego cannot be dented because the board disagrees with their conclusion. This is tough when the manager is convinced the board is acting foolishly, but the manager does not always know the political issues the board may be dealing with.

Now for the capital reserve expense

Some boards like to break down capital reserve into subcategories. For example, roofs, road replacement, balcony replacement and perhaps others. This is not a bad idea but can cause a problem. It smacks of ‘fund accounting’, where once the money has been allocated to a specific category, roofs for instance, the money can’t be moved into road repairs. If the roads break up, the association would not be able to fix them. If the association decides to break its capital reserve into categories, make certain the minutes reflect that it is not the board’s intention to be bound by the allocation. This may well prevent some resident angst.

Just about every finance director involved with community associations will recommend an accrual system for setting up and maintaining the association’s books of account. This is very difficult for most board members when they try to make head or tail of their monthly financial report from the management company.

Try to explain to the board member that the total income shown for the month is not the income that really came in but just the projected income, and … you see the point.

There are certain items of expense that are frequently not identified in a budget and they should be. Categorising costs under ‘miscellaneous’ is a big mistake. The one biggest problem concerning budgets occurs when a resident who is already upset about some perceived unfair event sees ‘miscellaneous’ in the budget. The automatic assumption is that someone is getting the money for their personal gain and simply calling it ‘miscellaneous’.

There are several items that should not be put in ‘miscellaneous’ and must not be forgotten. Some examples of these items are membership of ARC, a bereavement fund for cards or flowers for residents who have suffered a loss, congratulations fund for residents who have had some special event take place, like a birth of a child, a marriage, a confirmation or bar mitzvah, board meeting costs to include renting the hall and any meal brought in for the board members, or holiday celebrations like Christmas parties that the entire community is invited to attend.

Now that all the categories have an expense and a rationale assigned, it is time to total everything up. If an increase in monthly levy is needed, so be it, if the projected budget is not just a wish list. Multiply the total by each resident’s percentage of ownership, divide by twelve, and that results in the new monthly levy for the year. This is what is presented by the manager to the board.

The real test of the manager comes now. The draft budget must be presented to the board for final approval. Each board approaches this responsibility differently. Some will go over each line item and discuss the issues that were considered in developing that estimated cost, and others will ask for questions, and, there being none, approve the budget as submitted. Irrespective of the board’s approach, the manager should be prepared for the probing questions they will get from an interactive board and not slack up on the preparation of the draft budget.

It may take more than one meeting to approve a budget. Many associations set up an ad hoc committee just to deal with the budget; when the budget is approved, the committee folds. However, at some point, the budget must get approval. If the approval takes place in December or later, there is not enough time to properly notify the residents. If the budget results in a levy increase, residents become very upset if they simply get a letter and are directed to just send in the new amount. A nicely worded letter explaining the need for the increase and how it will benefit the resident is very important. This letter should precede the letter with the new levy and the coupons. This approach provides a little sugar to make the medicine go down easier.