As a homeowners association (HOA) member that pays fees each month, it’s only right that you know what your money is being used for. One of the most important tasks of an HOA board is to allocate these funds. HOA fees are usually distributed to two accounts: operating funds and reserve funds. While both accounts are essential in maintaining your community, they have separate functions. If you want to learn the difference between operating funds vs reserve funds, here’s an in-depth explanation.
In this article:
Operating Funds vs Reserve Funds: What Are They?
When it comes to community management, there are two major areas of spending: (1) daily or recurring expenses and (2) large-scale repairs and replacements as well as unexpected expenses. Accordingly, HOAs also have two accounts for these expenses — operating funds and reserve funds. Both are funded by the association fees that homeowners pay each month.
What Is an Operating Fund?
The operating fund is used for expenses incurred in the day-to-day operations of the community. These are expected expenses that happen daily, weekly, or monthly.
Here’s a breakdown of expenses covered by the operating fund:
- Services (housekeeping, landscaping, maintenance, security, trash disposal, etc.)
- Utilities (electricity, water, gas, sewage)
- HOA Management (HOA manager salary, office supplies, postage)
- Accounting Fees
- Legal Fees
- Software Fees
As you can see, the operating fund covers a lot of things. These expenses represent a large part of your community’s financial transactions. However, this is by no means an exhaustive list. Your operating expenses will depend on your community’s size and assets.
How Much Money Should Be in the Operating Fund?
Operating funds do not have a required minimum amount. Ideally, the account should be able to cover at least 3 to 6 months of operating expenses. It’s important for associations to have a clear collection policy so that income generated from HOA fees will always be enough to cover your monthly expenses. If not, the HOA should consider trimming the budget accordingly.
What Is a Reserve Fund?
The reserve fund is used for large-scale repairs and replacements, as well as unexpected expenses or emergencies. It’s similar to a savings account; the money will only be used when there is a need for it.
Here are examples of scheduled expenses covered by the reserve fund:
- Repaving roads
- Replacing or adding sidewalks
- Painting of community assets
- Roof replacement on common buildings
- Pool repair/Pump replacement
- Major landscaping projects
- Construction or renovation of amenities (playground, gym, basketball court, tennis court)
The reserve fund can also be used for unexpected repairs or replacements. For example, roof replacement is usually scheduled every 10 to 15 years. However, if a bad storm damages the roof of the clubhouse, the board can tap into the reserves to pay for this urgent expense. As such, the reserve fund should be highly liquid. Do not tie it to long-term investments.
How Much Money Should Be in the Reserve Fund?
HOAs should have a reserve study to determine how much money should be in their reserve fund. A reserve study is usually conducted by a reserve study company every 3 to 5 years. After physical and financial analyses of your community, a reserve specialist will come up with an estimated amount for your reserve fund.
Ideally, you want your reserve fund to be 100 percent funded. If money is tight, associations should at least strive for a 70 percent reserve level. Also, you should not use reserve funds to cover operating expenses.
How to Manage Operating Funds and Reserve Funds
While there’s a need to differentiate between operating funds vs reserve funds, it’s also important to see how these two work in tandem. A community cannot grow without both accounts. A community also cannot succeed if operating funds and reserve funds are not managed properly, effectively, and legally.
In a self-managed community, the board takes on the responsibility of managing association funds. Board members need to have a solid understanding of accounting and financial management. Otherwise, they may become overwhelmed with more complex tasks such as accounting, bookkeeping, and budgeting.
A lack of financial expertise can lead to costly errors or mistakes. If the board mismanages funds, the community may not have enough money to cover operating expenses. Or, in case of an emergency, the community may not have enough reserve funds to pay for urgent repairs. To avoid bankruptcy, the board may decide to levy a special assessment.
What Is a Special Assessment?
A special assessment is an additional fee that homeowners have to pay on top of the monthly fees. It’s not a recurring charge, though. The board will only levy a special assessment when funds are insufficient.
While special assessments can help associations recover, it places a lot of the financial burden on the homeowners. Residents have many other financial obligations and the sudden increase of HOA fees can lead to a lot of stress. If they cannot cope with the HOA fees, they may become delinquent. You have to avoid delinquencies because the income generated from HOA fees are a major factor in your ability to manage the community.
When to Consider Financial Management Services?
HOAs exist to make property owners’ lives easier. If your community is constantly struggling with finances, it might be time to hire a financial management company. An HOA manager will be able to take care of the financial responsibilities of the board. They also have the appropriate tools and resources to ensure the financial stability of your community. As a result, the board will have more time to focus on other more important community matters.
A Solid Understanding of Operating Funds vs Reserve Funds
Proper financial management is one of the most important jobs of an HOA board. If you’re a newly appointed board member, it’s important to have a solid understanding of operating funds vs reserve funds. While the financial aspect of community management can be overwhelming and time-consuming, your hard work and dedication will pay off in the long run. You’ll be able to see the success and growth of your community. If you want to know more about financial management, don’t hesitate to give Clark Simson Miller a call.
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- Can HOAs Ask For Special Assessments?
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