PREPARING ANNUAL BUDGET IS NOT EXACT SCIENCE

Creating a good operating budget can be very time consuming and when it is completed everyone involved may still question if it is “accurate.” The best way to gain comfort in the process is to understand that the goal is for the budget to be “reasonable” and not exact, since you simply want a best guess at future results.  The property management firm is normally in the best position to create a working draft of the annual budget for the board members to start the budget review process.

It is important to understand presentation alternatives for the budget and the sources of annual

budget information. Depending on the association, the budget may be prepared on a cash, accrual, or modified accrual basis. Cash basis is simpler to understand since revenues are

recorded when received (i.e., condo fees deposited in the bank) and expenses are recorded when paid (i.e., writing checks to pay vendor invoices). Accrual basis is more complicated with revenue recorded when earned (i.e., condo fees are due the association but not yet paid by unit owners) and expenses are recorded when incurred (i.e., the association has received goods or services but will pay for them in the future).

The modified accrual basis is simply a combination of both cash and accrual accounting methods. Keep in mind there is no one rule for which method to use, but be consistent to avoid confusion in the reports being created. I would suggest the board members, property manager and accountants for the association discuss the method best suited for their needs, given the ongoing reporting requirements of the association.

After the method has been determined, the underlying assumptions of each budget line item should be gathered and documented. To make the process less time consuming, most management firms have a template for creating budgets using either Excel or Lotus spreadsheets or the firm’s in-house accounting software.

If a template does not exist, the association’s accounting firm can assist with creating and/or tailoring a template to suit its requirements. The spreadsheet template should allow allocation of

monthly income and expenses, but if not, I strongly suggested creating one that allows this level of input. The benefit of budgeting on a monthly basis is that it enables the association to respond sooner to variances in each month’s actual results versus each month’s pre-determined budgets.

In reviewing a specific budget line item, separate data sheets work best for each expense category. Information typically found on these data sheets includes: general ledger account number, account name, monthly budget dollars current year, monthly budget dollars last year, monthly actual dollars last year, and summary totals for each category.  These sheets should also include a narrative assumption section that lends support for the new budget the board and property manager will be adopting. Please keep in mind that the assumption section is useful not only for the current year budget but also for future years as well, since it highlights the source of budget information. The summary annual budget total should be automatically calculated and linked to a sheet that lists every budget expense account.  The summary annual budget gives the board a usable document to communicate to unit owners the new budget for the year in a concise and readable format.

To this point we have only reviewed the basic of creating the operating “budget” of the association. The association must also prepare a “reserve” budget for major repairs and replacements. The reserve budget focuses on major items such as roofing, roadways, and other long-lived assets. Most associations are best served by hiring an engineering firm that specializes in preparing reserve (cost) studies which commonly provide a 20-year annual projection of reserve expenses.

There are also several larger property management firms that offer this service for a separate charge for the annual management fee. I do not recommend the board taking on this task as you may create liability exposure for not identifying all potential problem areas. If you board does elect to create the study themselves, I would suggest consulting legal counsel as to the liability for performing this task. The important point about reserve analysis is never to overlook it as part of the budget process since it is an integral part of the annual budget numbers.

The final and most difficult part of budgeting is being realistic about what the expenses will be for the upcoming year. The prior year(s) history is the best indicator of future expenses but they must be adjusted for inflation or known increases beyond inflation.

If your association makes annual special assessments then the budget process may need revamping.  The scenario that frequently happens is the board, the property manager, or both become split on a zero to two percent increase versus a three to five percent increase. When the lower increase is selected, either in the current or subsequent year, a special assessment is probably mandatory since funds may fall short to cover expenses.

The board, in keeping increases low for unit owners, has made its job and the property manager’s more difficult. Therefore, mild budget increases each year help to build reserves and pay operating expenses and ultimately reduce the time and stress of all parties involved.