In the first blog in this series, we covered the basics. A focal point of that piece was clarifying the real goal of a budget. It’s worth repeating:

Focusing on the purpose helps stakeholders gain clarity and provides context. It also gives them some tools to make tough decisions when needed.

The Past, the Present & the Future

The inability to predict the future is a common human weakness. We really stink at it. And yet, predicting the future is what budgeting is all about. While, we will never get it exactly right, we can hedge our bets with sound methodology.

This methodology will also help to avoid other all too human foibles. Ignoring the past is always a fantastic way to ensure disaster. Seeing past our biases to recognize current realities can also be a challenge.

Trend or Zero-Based?  Both!

There are two basic budgeting methods – “trend” and “zero-based.” Trend budgeting uses the current year’s budget as a baseline and assumes an incremental increase each year thereafter. For example, if the landscape non-contract line item is $10,000 and the annual inflation assumption is 2%, the budget for the following year will be $10,200. Frequently, the same multiplier applies to all line items. There may be some variations from line item to line item in the actual expenses during the year. However, the hope is that the overall bottom line will come out about right. Do communities apply the same percentage to all line items?

Zero-based budgeting is far more robust. It is commonly utilized when drafting a budget for a community that has not been built yet. Those writing these budgets use all available information about the planned project. They attempt to visualize what it will take to operate the property when built. Finally, they proof each operating line item for accuracy against similar properties and industry knowledge.   The reserve contribution line item is calculated by creating a reserve schedule, compiled using RS Means data and construction figures provided by the developer.

The best budgets for existing community associations use elements of both methods. Every single line item should be scrutinized and challenged with a fresh set of eyes each year. The analysis may result in some cost savings, or it may result in creating new line items to reflect expenses not previously required. At the same time, history and current conditions help predict the future, like it or not. Uncontrollable trends cannot be ignored. They must be reflected in the affected line items. Assembling the information necessary to analyze data from the past and seeing the present clearly will go a long way towards creating a viable plan for the future.

Why All the Work?

One benefit to this approach is that it helps to build trust. Members, who are reasonably concerned about how their money is spent, are more likely to recognize the scholarship woven into the process. The budget document will provide some level of comfort that money is not being spent needlessly. It isn’t something conjured up to make the numbers look good, or to achieve some political purpose. The figures represented in each line item mean something. They’ve been vetted thoroughly. They are grounded in reality and reason.

The discipline inherent in the methodology can also help to explain reality to homeowners. It is simply not realistic to imagine that HOA fees can remain flat when rising costs impact every other facet of life. Any architectural, mechanical, electrical, landscaping, or plumbing component becomes more expensive as it ages until it is finally replaced. I like to share an automotive analogy to help make it real. I can make a classic ’57 Chevy Belair my daily driver. But my running costs are going to be much higher than if I bought a brand new Honda Accord. If I fail to recognize that reality, I won’t have the money to keep the Chevy on the road.

What’s Next?

With the basics and methodology covered, we are ready to explore the components of a great association budget. That will be Part 3 of this series. Stay tuned!

Budget season for community associations with calendar year-ends are upon us. Even though I’m no longer responsible for writing several budgets each year any longer, I could feel it coming. Thirty years in the management business re-wires your brain, I suppose.

It might sound odd to some, but I always looked forward to budget season. It found it was an opportunity to establish and build upon the partnerships I enjoyed with my clients. I found that once I wrote a budget for a client for the first time, the exercise put me in a position to have full command of the operation. I noticed that by upgrading the budget document and process, I earned immediate credibility with my clients. The boards understood the numbers and had confidence in sharing the information with their communities. I also got the opportunity to collaborate with on-site personnel, which was a great way to help them to have input, for me to better understand their day-to-day challenges, and to build our team from the mutual respect the process required. It was a LOT of work. We took no shortcuts. But it was worth it. The community members were well served, everybody learned a lot, and it as a blast, even when the results were difficult to communicate! I will never forget standing in front of a large group of owners explaining why their developer’s budget created the need for a 24% condo fee increase the first year after transition. 25 years later, that condominium still stands, thanks in part to the tough work we did together those first couple of years.

Thanks to great training and a boss who gave me his torch to carry and the freedom to expand on the fundamentals he taught, after a few years I became the semi-official Budget Guy. I taught the process to new managers and helped other managers out when they got stuck, or were nervous about sharing a difficult message with their clients. I got to present an annual budget workshop for the management company for a few years. In 2011, I was asked to co-present on the topic for the Montgomery County (Maryland) Commission on Common Ownership Communities. We had so much fun, the crowd gave us an ovation at the end. Attendees from the concurrent sessions were shocked to hear people’s enthusiastic response to a budget program! That was followed by a lengthy recap in the COC’s newsletter.

I dusted off that old article and realized that a multi-part blog format allows us to share the best practices and tips picked up through the years without the constrictions of print space or seminar time constraints. As with everything else we share on this blog, we hope the series saves you some time, gives you a tool or two you can use, and helps you to avoid some of the quadrazillion mistakes I’ve made through the years. Maybe, just maybe, you will come to enjoy budgeting as much as I do and find the same benefits I was able to reap. So here we go!

Let us start at the very beginning…

BACK TO THE BASICS

The story goes that famed football coach Vince Lombardi opened every Green Bay Packer preseason camp with the same introductory sentence. Raising the pigskin high enough to be seen by the 50 or so professional players in front of him, he intoned, “Gentlemen, this is a FOOTBALL…” He understood the importance of reinforcing fundamentals.

So what is a budget? It is an essential part of association operations as the first of the three interrelated financial phases – planning, operations, and review. Deficient planning in the budget process leads to poor performance in the operating phase as reflected in monthly financial statements. Inevitably, this leads to poor results in the review phase, the annual audit. Conversely, excellent budgets lead to solid operational results and contribute to nice, clean audits. Creating a budget is not an isolated exercise or theoretical effort. It has real impact.

Done properly, budgeting lays a foundation for financial and community success. Done poorly, serious short and long term difficulties are sure to be created or perpetuated. We’ve been helping a number of clients dig out of financial trouble. Sometimes replacement reserves were underfunded directly with the “transfer to reserves” line item being set too low. Other times, reserves are underfunded indirectly. Unrealistic operating budgets lead to deficits. After paying the bills, there was not enough money left to fund the reserves from month to month.

Regardless of the reason for insufficient reserve funding, there’s always telltale signs of chronic under budgeting: A belief in the myth of saving money and deferred maintenance. Budgeting low out of fear of increasing fees has a vicious and compounded boomerang effect. Deferred maintenance results in exponentially higher fees for the members in the long run. Maintaining components past their useful lives is very costly, and can include the collateral damage from water leaks and emergency remediation. Higher fees are also required to help fund capital expenditures made more expensive by emergency replacements, exponential deterioration, or interest costs for debt service. Look at the exhibitor list from any CAI conference. You’ll see plenty of bankers there. There’s a reason that market niche is growing. Many associations have under budgeted for years and are now forced to pay the price…a very high one.

So let’s get back to the basics and get this right.

WHAT’S THE GOAL?

What is the purpose of the budgeting process? I ask this question when I teach financials to community association volunteer leaders. Sometime I get some pretty good answers. But I always find myself compelled to say, “I guarantee that a percentage of you don’t want to say out loud what you believe – that the purpose of the budget process is to keep fees as low as possible.” True, it is the board’s responsibility to the community to use funds wisely and avoid waste. But read any governing document and you will find the primary responsibility of leadership is to maintain the common elements and collect fees sufficient to do so. Of course there is more to a budget than accounting for the sticks and bricks. Quality of life is largely determined by the service levels provided for in the budget.

GUTS, PART ONE

Too many managers are either nervous about proposing budgets with increases, or intentionally propose budgets with low or no fee increases as way to stay in the good graces of their clients. Don’t get me wrong, in rare cases, no increase can be possible. I even had one client who reasonably decreased their fees after paying off a loan. But when it’s done for political reasons, it’s a slippery slope. For the nervous, we’ll offer some perspectives and strategies in the following segments to help. For the political animals, please stop. Sucking up is not customer service. You aren’t helping anyone in the long run, including yourself.

Boards and Finance Committee Members get nervous, too. It’s completely understandable. They must answer to their neighbors. The nervousness means you take your responsibility seriously. You are to be commended! We hope this series of blogs helps.

It takes guts to take the long view. But that’s what leaders do. Outstanding professional managers and community volunteers know they are leaders first and foremost.

COMING SOON…

In the coming segments, we will continue to outline fundamentals of budgeting. First, we will review budget methods to help analyze the past, see the present, and plan for the future. Then we will identify critical budget components and tips for assembling and presenting them. With the fundamentals covered, we then get to the really fun stuff. We will cover strategies for communicating difficult news…like a 24% fee increase. Then, we’ll finish up with how to avoid common mistakes and a final exhortation to stay the course.

I know I’ve been a bit of a deadbeat lately in the blogging department. Sorry about that! Chantu’s been doing her part, but I haven’t been shipping. Business has been great, but that’s no excuse. I’ll try to make it up to you by delivering upcoming blogs more quickly so you can have them at your disposal as you dive into your budgets.