There are really two starting points in preparing your Association budgets. The first is to start from scratch and zero out all line items from the previous year. From there, contracts would be reviewed to determine the amounts to input in the line items, and all other known income and expenses would be inserted. The other starting point would be to use your prior history. In other words, you would work with your prior year's budget and tweak the figures depending on any known modifications to services.
When would you start from scratch on your budgets? My personal choice is to start from scratch once every three years, and to do the budget from scratch the same year the Association is conducting the full reserve study with the on-site inspection. There is a reason why statutes require Associations to conduct full studies every three years, and that is to maximize the accuracies of the report. We know the report will never be perfect. I can understand why statutes don't put such stringent requirements on operating budgets, as replacement of reserve components are far more costly than a lot of these operating line items. Nonetheless, it is good management practice and is a pro-active approach to budgeting.
At minimum, if a new Board is taking over from a prior Board, or if a new management company is in place, we should not assume that the work of the prior Board or company is accurate. We should be budgeting from scratch to verify that the budgeted figures are reasonable, and to see if we need to add or remove certain line items altogether.
I heard a story today where a community had been self managed for about 20 years and then hired a property manager. The professional manager worked for the community for 4 years and really assisted the community in conducting their reserve studies and help map the community's financial direction. After 4 years, the manager moved on to a different community. Meanwhile, the Board of Directors had noted that the reserve funding percentage was not in a desirable range. They arbitrarily decided to remove the reserve line item for their roofs, which of course substantially increased the reserve study funding. The Board instructed the reserve study company to completely remove the roof from the reserve study component list, and the reserve study company responded and advised against doing this because this would be blatant inaccurate reporting. The Board chose to disregard the reserve study company's advisement and pressed to remove the roofs. Another few years passed and the various new Boards and managers did not catch this removal. The Board's fiduciary duty is to rely on professionals to guide them, and instances where the Board of Directors opt to act in a manner that contradicts professionals is when Board Members can be deemed to be acting negligent or in bad faith. When the roofs finally needed to be replaced and homeowners were assessed over $25,000 each to fund the project, the Association pursued filing a claim on their D&O Insurance. When the insurance carriers subrogated the claim, the carriers were pursuing those individual ex-Board Members, who were personally liable. Remember that as long as Board Members use the business judgement rule and are acting in good faith, Board Members do have protections from being personally liable. In cases like this where they clearly took actions to cover up their funding percentages for whatever reason, they were acting in bad faith and were considered personally liable. My point in this story, is that had this community started from scratch when the new Board / Management came in, this would have been discovered well before the roofs became dilapidated.
The moral of the story is, while it may take us a little extra time to start from scratch, we should be pro-active and use our reasonable judgement to determine when it is necessary to prepare a budget from scratch.
If you have any questions regarding community management, feel free to contact me at NedaFirouz@gmail.com.
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