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Director’s Financial Responsibilities

The new Association director is often thrust into the job with little idea of what his or her duties and responsibilities are, other than the conceptual knowledge that s/he is obligated to serve in the best interest of the Association. Unless s/he has been an active member of CAI (which is not likely if s/he is a first-time director), s/he is not even aware of the educational resources that are available for guidance in learning what a director’s responsibilities are. Further, many directors serve only a one-year term and therefore have little incentive to go through the effort of getting the education necessary for performing their job, since their term will be completed before they can even begin to learn everything they should know.

The purpose of this article is to attempt to provide guidance to the director on his or her financial responsibilities. The most important rule with respect to financial transactions is that they should be well-documented. While the Association may produce monthly financial statements and an annual budget, it is also important to document (preferably in the minutes of the Board of Directors) the following types of financial decisions:

  1. Authorization for new bank accounts
  2. Authorization of changes in signers of bank accounts
  3. Approval of transfers of cash between accounts
  4. Authorization for purchases of major equipment, or major expenditures
  5. Approval of the annual budget
  6. Acceptance of monthly treasurer’s report
  7. Acceptance of monthly interim financial statements from the management company
  8. Approval of the annual audit or review report and tax return
  9. Authorization for an officer of the Association to sign the annual income tax returns
  10. Documentation of board actions and responses with respect to the accountant’s management letter that accompanies the annual audit report
  11. Collection actions (authorization to lien member property, authorization to foreclose on member property)
  12. Documentation of board decisions regarding insurance coverage
  13. Adoption of a conflict of interest policy
  14. Authorization of contract for preparation of a reserve study
  15. Authorization of reserve expenditures
  16. Adoption of reserve policies
  17. Adoption of Revenue Ruling 70-604 Election (This election should be made annually and should preferably be made at the annual membership meeting, then ratified at a Board of Directors meeting.)

Accounting is a complex, technical subject in which very few people have an active interest. However, the impact of financial transactions is something that permeates every aspect of our lives, and certainly that of a community association. While no individual can be given a complete accounting education in a short enough period of time to enable them to gain a complete understanding during their term of office, there are certain things that the director can and should do on a procedural basis that would allow him or her to adequately exercise the oversight of financial responsibilities of the members of the Board of Directors of an Association.

The director needs complete financial information in order to perform an adequate review of transactions. Accordingly, the monthly financial reporting package for a community Association should generally include the following documents:

Monthly financial statements

a. Balance Sheet on an accrual basis

b. Income Statement on an accrual basis with budget-to-actual comparisons ( The income statement should include both current month and year-to-date amounts.<

  • General Ledger
  • Cash Disbursements Journal
  • Aged Assessments Receivable Listing
  • Copies of all bank reconciliations
  • Copies of all bank statements
  • Copies of paid invoices

While the above list may seem like overkill to some, these documents should be distributed to the board members prior to the Board meeting so that they have an adequate opportunity to review them and be ready at the time of the meeting to either approve the reports or ask the necessary questions. It is not reasonable to expect even a CPA to be given a set of financial statements during a Board meeting and on the spot, have to review, understand, and approve the financial statements and, by inference, the underlying transactions.

For the director to competently review this financial package, he must have a basic understanding of each of the documents.

The balance sheet is a statement that reflects the financial status of the Association at a specific point in time (generally month-end or year-end). Common components of a balance sheet are:

Assets

Cash – Petty cash on hand or in checking accounts, savings accounts, or other types of accounts with a financial institution

Assessments Receivable – Amounts owed by members to the Association as of the date of the financial report

Fixed Assets – Property acquired by the Association with a useful life greater than one year and of significant cost

Prepaid Expenses – Payments of expenses in the current period that will benefit more than one period, such as insurance, which is often paid in a single payment for an annual premium

Liabilities

Accounts Payable – Expenses incurred, but not yet paid

Prepaid Assessments – Dues/assessments paid in advance

Income Taxes Payable – Income taxes due for the current year and any prior years

Fund Balances

Operating Fund – Accumulated earnings or losses of the Association from the current and prior years.

Replacement Fund – Amount set aside for future repairs and replacements (this balance should have an equal amount of cash set aside to accumulate for major expenses).

The income statement reflects, for a period of time, the income and expense activities of the Association. A preferred format would reflect both the current month’s and year-to-date budgeted and actual activities. Revenues generally consist of member assessments, fines, vending machine, parking, or other income and interest income. Expenses would include operating maintenance costs, utilities, management company fees, and other administrative and operating fees. Amounts transferred to reserves are generally reflected as an expense of the operating budget, unless financial statements are prepared on a fund basis.

The general ledger is a document which underlies the financial statements and summarizes all activity by account. For instance, if three different checks during the month were written for repairs, they would be grouped into the repairs expense account (even though the checks were not in sequential order). The total of those three checks would represent the current month’s total repair expense, which should agree with the income statement. This document can be used by the director to research questions such as “what is in utility or repair expense this month?”, and “why is it so high compared to prior months or prior years?” The general ledger should provide sufficient detail for you to find the answer to that question.

The cash disbursements journal is simply a listing of checks in numerical order for the current month, listing the date, payee, and amount.

The other reports are self-explanatory.

The procedures that the director might employ in analyzing these documents should consist of:

  1. Examine the balance sheet and compare it against prior periods to see that cash balances and assessments receivable balances appear reasonable. Note if there are any significant fluctuations between restricted reserves in the current period versus prior periods.
  2. Examine the bank reconciliations and see that they agree to the amounts reflected as cash on the balance sheet. Investigate any differences. Also, make sure they agree with the bank statements. The bank reconciliation should begin with cash per bank and reconcile down to cash per financial statements and general ledger. The reconciling items will generally consist of deposits in transit and outstanding checks. Investigate and question any large or old outstanding checks.
  3. Review the bank statements to ascertain that all interest income has been recorded in the financial statements.
  4. Make sure that all bank accounts are recorded in the general ledger of the Association.
  5. Examine the aged assessments receivable listing and compare it to the balance sheet. The total of assessments receivable should agree with the balance sheet.
  6. Review the aged assessments receivable listing and question any assessments receivable that are more than 30 days old. The Association should adopt a strict collection policy that would consist of assessment of late charges, warning letters, filing of a lien, and ultimately foreclosing on member property for non-payment of assessments. There should be no exceptions to these rules, especially for directors of the Associa­tion.
  7. Review the income statement comparison of budgeted to actual activity both for the current month and the year-to-date, and question any significant variations.
  8. For any questioned income or expense items, trace the account to the general ledger and review the detail for that account.
  9. Review the cash disbursements journal for the month and challenge the propriety of all expenses. For instance, if any checks are written to any director of the Association, find out why. If the management company is being paid more than their contractual fee, find out why.

It will take some time for the director to perform all of the above procedures, but it will provide you with insight as to the financial transactions of the Association, and a greater understanding of how your Association operates. While this may seem like too much work to be done on a monthly basis, you as a director have an obligation to the members of the Association to safeguard the assets of the Association. Only through diligence and a step-by-step procedural review of transactions can this be done.

Financial Fundamentals – What Every Small Business Owner Should Know!

Business owners rarely go into business to deal with the financial aspects of running a business. It’s easy to understand why! You are passionate about the products or services you provide and want to focus your time there. The financial aspect usually falls to the bottom of the “desired responsibilities” list. It is critical to the long-term success of your business that you understand some of the Financial Fundamentals of being a business owner though. You don’t have to be an accountant or financial analyst, but it is important that you have some key skills in your business toolkit to measure the financial aspects of your business. It’s okay to outsource this activity so that someone else can do the work you don’t like to do, but make sure you understand the output of the financial information. You’ll need it to help you make informed decisions about your business. Remember! Accounting is not just about taxes. There’s so much more to know about the numbers, so you’ll know how your business is doing from the management perspective.

There are a variety of key aspects of your financial picture that you need to be aware of and they can be outlined based upon the three critical financial statements: Profit/Loss, Cash Flow, and Balance Sheet.

I meet with entrepreneurs every day that are unsure of their profitability. They “think” they are making money because they have money in their checking account. This is NOT how you should be running your business. Having money in your checking account doesn’t mean you are profitable. It could mean you haven’t paid all the bills so you have a little cash. Cash and profit are two different concepts. If you aren’t profitable, you won’t have longevity in your business.

So what is the difference between profit and cash? Profits are determined through an equation of Revenues – Cost of Goods Sold = Gross Profit – Overhead Expenses = Net Profit. This equation is the makeup of your Profit/Loss Statement. Revenues are dollars from generating sales within your business. Cost of Goods Sold reflects the direct costs for labor and materials incurred in your business. Overhead Expenses are all those other costs that you incur so that your business can function (i.e. Rent, Taxes, Insurance, Marketing, Accounting, etc.)

You can have activities that affect cash but are not considered revenues or expenses. For example, when you borrow money from a lender, it is not considered income. It is classified as an increase in your liabilities (i.e. debt). When you repay that loan, it will not be considered an expense. It is a reduction in your liability. Any interest you might incur on that loan would be classified as interest expense, but the principal portion is not. Similar concept applies for owner investments and withdrawals.

Often times the two concepts of cash and profit are not clearly defined for small business owners; therefore, you don’t have a good handle on your finances and how to interpret any outcomes from financial reporting. You can show a profit and have a negative cash flow if your loan payments, owner withdrawals, and other non-expense activities are taking more cash out of your business than you have profit. Same goes for the opposite flow, you can have a lot of cash coming into the business through an increase in personal or lender-financed activities vs. revenues. The most basic of cash flow statement information can be outlined as Beginning Cash Balance + Cash Inflows – Cash Outflows = Ending Cash Balance. It’s important for you to understand the concept of your Profit/Loss Statement and your Cash Flow Statement. They provide two different views of our business.

The third financial statement you should be preparing monthly is the Balance Sheet. The Balance Sheet provides information on your Assets, Liabilities and Equity. Assets are what you own that is of value. Examples include Bank Accounts, Accounts Receivable, Inventory, Property, Plant, and Equipment. Liabilities represent your obligations to others. Examples of liabilities include Accounts Payable, Notes Payable to Lenders, Loans from Shareholders, etc. The Equity balance reflects the value of your ownership in our business. When you take the value of the assets less the value of your liabilities, the remainder is your equity.

It doesn’t matter the size of your business, profitability and ongoing financial stability is something you should be monitoring on a regular monthly basis. Some will say that they are too small for creating financial statements. That is your way of not holding yourself accountable to managing your business wisely. It’ll always be someone else’s fault when your business fails…or at least that is what you’ll say. Though it won’t be the truth, it’ll be your fault for not managing your business wisely. You can choose to succeed, or to choose to fail. It is always a choice, not a default. So make the choice to be a financially informed business owner. Your business will thank you through increased profitability and longevity!