By Elizabeth Caswell Dyer, Sopra Communities Inc.
To begin, a budget’s purpose is to plan out what is needed for cash flow for a period of time. It can also function as a planning tool, depending on the template used. Some associations function on a calendar year (January-December), and some function on a fiscal year, which is any twelve month period, such as June 1st to May 31st. Every budget should have these components to it: Income (Assessments), Expenses, Savings (Capital Reserve Transfers), and Debt Service (if applicable).
There are four main methods or philosophies that inform budgets:
Incremental: Incremental budgeting takes the previous years’ numbers and adds a set percentage increase or decrease across the all line items to arrive at the new numbers. It’s the most simple format, but is really only appropriate if what are called “cost drivers” don’t change. The cons are noteworthy, in that this type of budgeting encourages inefficiencies, overstatements of needs, and ignores variables such as inflation.
Activity Based: This is a top-down approach that begins with revenue projections and then looks at expenses through the lens of achieving the revenue goal set by the projections. This is a common approach in other multi-family situations, such as apartments. As HOAs are generally expected to budget to get to zero as of midnight on the final day of the budgeting period, this approach is backwards of what is needed, as expenses tend to drive an HOA budget and assessments are calculated based on what is needed to properly run the association.
Value Proposition: This method is more a philosophy, and it’s all about value - anything included in the budget must deliver value to the corporation. It’s a lens of justification and looks to eliminate anything unnecessary.
Zero Based: This is a very common approach and starts from scratch each year, with all line items beginning at zero. There is a value proposition component, where every expense must be justified. This is often referred to in the common slang as a “tight” budget with only what is actually needed included. It’s also an expense driven viewpoint, which is the opposite of the Activity Based approach.
Over the years, I have found it to be beneficial to take a blended approach. For example, if the equipment that drives the utility numbers has not dramatically changed, it is very accurate to get a sense of what percentage increase to expect from the various utility providers for your association, and then overlay that percentage on top of the previous years’ actual numbers. Our team does this by month, and it has resulted in variances being minimal as long as the expected percentage we’ve been given ends up being the actual increase.
For contracts, these are also constant expenses where the expected increase )either due to union rates changing or increases noted within the contract) can be added to the previous years’ actual numbers and reasonably entered into the budgeting template.
Other items, such as landscaping, are informed by the goals of the Board of Directors in terms of long-term planning (and sometimes hopeful thinking).
There are line items nobody really wants to spend money on, but it has to be done. These are your mechanical components, such as HVAC, Plumbing, Electrical, and Roof. These are best budgeted by looking back in those line items in financial reports over a series of a few years, if possible, to see an average of the association’s needs in these areas. Contingency planning in these line items can also be an approach to saving, because funds not needed for contingencies during the budget year can be transferred to reserves at the end of the year if the association comes in under budget.
Getting Started
If an association has been with you for a year, pulling a report called a 12 Month Trend or a General Ledger for the previous twelve months is an excellent place to start and to see how the actuals line up to the current budget in place. You may find you don’t need any funds in some line items, and you need quite a bit more in others than planned in the previous year.
Put everything in that you want AND need, and see what that expense total does to calculate the association’s dues. At that point, our team usually gives it to our CFO and then myself to look over and tweak before sending to the Board of Directors as a draft. The time to back things out is in a working session with the Board to reach “what the market will bear” in terms of the dues increase. Involving the Board in the editing process not only gives them the opportunity to exercise its fiduciary duty, it allows for buy-in from the directors that will be presenting to their neighbors, and many board members bring excellent insights and creativity to helping their association get where they want it to go for the next budgeting timeframe.
Elizabeth Caswell Dyer is the CEO of Sopra Communities, Inc. She’s passionate about Board and Manager education, especially good budgets.
