The financial analysis of the reserve study is the analysis of the association’s Reserve revenues and expenses. The goals of the funding analysis are to: (1) establish funding goals, (2) identify annual funding requirements, and (3) disclose limitations and assumptions. The financial analysis of a reserve study is an eight-step process as outlined below.
Obtain Component Information
The physical analysis involves the collection of information about the association’s components that are included in the reserve study. Once the physical analysis is complete, the reserve analyst will have estimates of the useful life, remaining life, and current replacement these components.
Determine Funding Goal
In preparation of the reserve study’s funding plan, the association’s board of directors will have to make a decision on the funding goal. The National Reserve Study Standards issued by the Community Association Institute (CAI) describes four funding goals or objectives:
- Straight-Line Funding – The objective of the straight line funding is to fully fund reserves on a per component basis such that the reserve funds are set aside in equal annual installments of the life of the component. This plan is the most conservative method of funding reserves, making it the plan that, if chosen, is least likely that an association will incur special assessments.
- Baseline Funding – The objective of the baseline funding is to maintain only sufficient reserves set aside so that the association never runs out of cash in the reserve fund to pay for reserve expenses. This plan is the least conservative method of funding reserves, making it the plan that, if chosen, is most likely that an association will incur special assessments.
- Threshold Funding – The objective of the threshold funding is essentially any funding plan that is between a full funding plan and a baseline funding plan typically described in either a cash target balance or percent funded target. This plan gives the board control over the risk that an association will incur special assessments depending on the level at which the threshold of this funding is set.
- Statutory Funding – The objective of the statutory funding is to comply with funding objective required by a local or state law or code.
All funding goals are designed to meet exactly the same expenses outlined in the physical analysis. However, the size of the reserve fund through the years is different. These differences can result in dramatic differences in the reserve contributions year-over-year if the association is to maintain the property, as well the risk of the association incurring a special assessment or needing to obtain external financing to fund reserve expenses.
Calculate Replacement Fund Liability
The reserve fund liability is then calculated by determining the amount of reserves that are required to replace the common components and then subtracting the amount of cash on hand for reserves. The detailed methods for this calculation are beyond the scope of this discussion. However, reserve analysts have a choice in methods in calculating the reserve fund liability.
Estimate Annual Association Reserve Funding Income
The ideal method for financing replacement reserves is from the association’s regular assessments. A specific dollar amount of regular association payments should be earmarked for the reserves, with the reserve funds being deposited into the reserve account when collected. This method for funding reserves is desirable because it spreads the responsibility for replacements over time. An alternative method for funding reserves is to levy a special assessment when the replacements. This method is less desirable since it allocates the costs to the owners who happen to be owners in the association during the year a particular component comes due for replacement.
Project Reserve Fund Revenues and Expenditures
The Physical Analysis provides the estimates for expected expenditures by year for each component. Adding these components requirements together, by year, gives the estimate of needed funds over a thirty-year period. The inflation rate will have a significant impact on the future replacement costs so it must be taken into consideration in the analysis of the reserve expenses. The association’s regular assessments and special assessments, if needed, are taken into are taken with any interest income after taxes are also considered in the reserve study.
Prepare Statements of Limitations and Assumptions
The reserve study will also document limitations of the reserve study as well as assumptions used in its preparation.
Issue Reserve Study Report
In preparing the funding plan, the association will have to make decisions about the amount of current assessments and the need for special assessments, balanced against projected liability. Currently, Florida law does not require the funding of projected replacement costs, only an explicit descriptions of the plan for such funding, among other specific disclosures. Clearly, however, the financial viability of the association will depend a great deal on the ability of the association to replace components as they wear out and not defer major maintenance items.
A product of the funding analysis process is the development of a funding plan (cash flow forecast or projection) to estimate future reserve cash receipts and disbursements. This is most easily presented in a spreadsheet format. All supporting assumptions and methodology should be carefully documented.
Professional reserve analysts may be able to advice the board on key decisions, but it is important for the board to understand each of these decisions, since they independently affect the overall results of the funding plan. Since the amount of regular assessments and the need for any special assessments should be indicated in the plan, these decisions will affect the owners’ monthly costs and property values. Because of their importance, each decision is discussed in turn, with an example showing how these decisions contribute to a long-term funding plan.