Practicing checks and balances in your HOA is a good way to protect the association’s funds, but not many boards even know where to begin. Fortunately, there are some steps you can take to ensure you keep your finances in check.
The Importance of Establishing Checks and Balances in Your HOA
Homeowners associations deal with a significant amount of money. These communities collect dues from homeowners, maintain reserve funds, and incur regular expenses. With cash constantly flowing in and out of bank accounts, there are bound to be some risks.
At the helm of every HOA is a board of directors responsible for financial management. Oftentimes, boards need help managing the community, leading them to hire management companies. And there is a potential for fund mismanagement or outright fraud — at the very least, the temptation for it exists.
Thus, it is essential for associations to enforce internal controls that aim to protect the HOA’s funds and reduce the risk of fraud. In the event that fraud does take place, these internal controls will allow the association to identify and trace it quickly.
When funds are lost or stolen, recovering them can be very difficult. This will ultimately lead to a budget deficit for the HOA, forcing the board to levy a special assessment, increase current dues, or take out a loan just to keep up with the community’s expenses.
How to Practice Checks and Balances in Your HOA
Board members have a duty to protect the association’s funds and manage finances with integrity. Try as you may, though, you will quickly find that successful financial management is harder than it seems, especially if you don’t implement the proper controls.
To help you out, here are the best ways to practice checks and balances in your HOA community.
1. Review Your Finances Every Month
Boards should make it a habit to review the association’s finances on a monthly basis. In some states, this is even mandatory. For instance, California Civil Code Section 5500 expressly requires boards to make a monthly review of the HOA’s operating account, reserve account, and financial statements, among other things.
In addition, it is well worth investing in fidelity insurance to cover financial misdeeds. Again, in some places, the law explicitly requires associations to carry this policy. Many associations are also required by their governing documents. While fidelity insurance does not prevent theft or fraud, it offers protection if it happens.
2. Don’t Give Too Much Power to a Single Person
In some communities, particularly smaller ones, complete control over the association’s finances is given to a single person. This is a dangerous setup as it opens the association to various risks. Giving one board member unbridled access to the HOA’s funds makes it easier for them to commit theft or fraud. It is also not a good idea to grant your manager unrestricted access to the association’s finances.
Assigning at least two people as signatories is a good way to practice checks and balances in your HOA. At least two board members should be responsible for deposits and withdrawals, while all board members should do their part to keep each other in check. With this type of setup, it will be easy to spot any discrepancies and call out a board member for paying a vendor more than the agreed fee.
3. Establish Payment Limitations
Even when you have a squeaky clean and honest board, the potential for theft or fraud is still present. Far too many boards put their total faith in their management company. But, managers are not invulnerable to temptation.
Your board should establish limitations regarding how much your manager can withdraw or sign checks for. Maybe you can allow your manager to pay the usual utility bills or ongoing contracts without supervision. But, for other expenses, it is best to have at least one board member sign off on it. While this limit can vary from one HOA to another, the typical threshold is $500.
4. Prohibit a Pay-and-Reimburse Setup
It is common for businesses to adopt a pay-and-reimburse setup. This is when managers or employees pay for an expense out of their own pockets in the meantime before asking for reimbursement from the company. For community associations, this is highly discouraged.
It is easy for a board member to inflate the numbers when you allow them to put an expense on their personal credit card and reimburse them later on. You can make an exception for verified emergencies, but defining what constitutes an emergency can be difficult. It is better to prohibit it outright to place a cap on it.
5. Institute Multiple Requirements for Reserve Withdrawals
Homeowners associations generally maintain two accounts: the operating account and the reserve account. While the operating account sees more withdrawal activity due to its nature, the reserve account largely sees more deposits. Thus, when a reserve withdrawal needs to occur, it must have the proper controls.
A good practice is to require at least two signatories for reserve withdrawals. In California, this is even mandated by law. Civil Code Section 5510 requires the signatures of at least two board directors (or one director and one officer) to withdraw funds from the reserves.
Civil Code Section 5502 even requires a written resolution of approval for transfers beyond $5,000 or 5 percent of the gross budget, whether from the reserve or operating accounts. This is another policy worth having, even if state laws don’t specifically mandate it. After all, it is better to have more protections than necessary to ensure the association’s funds remain in protected hands.
A Good Place to Start
Every association should establish internal controls to limit the risk of financial wrongdoing. By following the steps above, you can start practicing checks and balances in your HOA and safeguard the community’s finances.
Clark Simson Miller offers HOA financial management services, among other things. Call us today at 865.315.7505 or contact us online to request a free proposal!
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