Financial statements may look complicated, but their purpose is actually very simple: to help you understand the financial health of your association.

As a board member, you don’t need to be an accountant to understand your HOA’s finances. You just need to know what questions to ask and where to find the answers.

At the most basic level, your association’s financial statements should help you answer a few important questions:

What do we have?
How much cash does the association have? How much is in reserves? How much money is owed to the association?

What do we owe?
Are there unpaid vendor bills, loans, deposits, or other financial obligations?

What came in?
How much did the association earn from assessments and other sources?

What went out?
How much did the association spend, and what did it spend the money on?

Are we following our budget?
Are we collecting and spending approximately what the board planned?

Are we prepared for the future?
Are sufficient funds being set aside for major repairs and replacements?

Together, these questions tell the financial story of your association.

Imagine someone asks you a seemingly simple question: “How are you doing financially?” You tell them you earn $80,000 per year.

Does that answer the question?

Not really.

To understand your actual financial situation, we would need to know much more. Maybe you have:

• $5,000 in monthly expenses
• $15,000 in your checking account
• $30,000 in savings
• $18,000 remaining on your car loan
• $4,000 on a credit card

Your income is important, but it tells us only one part of your financial story.

We would also want to know:

What do you have?
What do you owe?
How much money comes in?
How much money goes out?
What are you saving for?

Your HOA works in much the same way.

No single report can tell you everything about your association’s finances.

Different financial statements answer different questions.

Think of them as different views of the same financial story.

“Where do we stand today?”

The Balance Sheet is a snapshot of the association’s financial position at a specific moment in time.

It tells you what the association has, what it owes, and what remains after those obligations are considered.

Think of it like: Looking at your bank accounts, savings, debts and other financial obligations today to understand your current financial position.

“What happened during the month or year?”

The Income Statement shows the association’s revenue and expenses over a period of time.

It helps answer questions such as:

Did we collect the revenue we expected?

How much did we spend?

Were expenses higher or lower than expected?

Did revenue exceed expenses—or did expenses exceed revenue?

Think of it like: Looking at your household income and expenses for the month to see whether you spent more or less than you earned.

“Did things go according to plan?”

Your budget represents what the association planned to collect and spend.

Budget vs. Actual compares that plan against what actually happened.

For example, perhaps the association budgeted:

Landscaping: $30,000

But actually spent:

Landscaping: $34,500

The report helps the board identify and investigate that $4,500 difference.

Think of it like: Creating a household budget of $5,000 per month and discovering at the end of the month that you actually spent $5,600.

The question isn’t simply that you spent more.

The important question is: Why?

Here’s one of the most important concepts to understand before moving forward:

Having money in the bank does not necessarily mean the association is financially healthy.

Cash in the bank ≠ money available to spend.

An HOA could have $300,000 in its bank accounts and still have significant financial problems.

Why?

Perhaps:

• $250,000 belongs to reserves and is intended for future projects.
• $40,000 in vendor invoices haven’t been paid yet.
• Homeowners owe the association $75,000 in delinquent assessments.
• Insurance costs are significantly over budget.
• A major roof replacement is approaching.

Looking only at the bank balance wouldn’t tell you any of that.

That’s why financial statements exist.

Each report gives the board another piece of the financial picture.

As a board member, your job isn’t necessarily to prepare the financial statements.

But you should be able to read them, understand what they’re telling you, and recognize when something deserves a closer look.

By the end of this guide, terms such as:As a board member, your job isn’t necessarily to prepare the financial statements.

But you should be able to read them, understand what they’re telling you, and recognize when something deserves a closer look.

By the end of this guide, terms such as:

Assets • Liabilities • Fund Balance • Accounts Receivable • Accounts Payable • Revenue • Expenses • Accruals • Prepaid Expenses • Reserves

should feel much less intimidating.

More importantly, you’ll understand how they connect.

And we’re going to start with the financial statement that shows where your association stands right now.

The Balance Sheet answers one of the most important questions a board can ask:

“Where does our association stand financially today?”

Unlike an Income Statement, which tells you what happened over a period of time, the Balance Sheet is a snapshot taken at one specific moment.

Think of taking a photograph.

A photograph doesn’t tell you everything that happened before or after it was taken. It simply shows you what existed at that particular moment.

A Balance Sheet works the same way.

A Balance Sheet dated December 31 shows the association’s financial position as of December 31.

Let’s forget about the HOA for a moment.

Imagine you wanted to calculate your personal financial position today.

You might start by listing what you have:

• Checking account – $15,000
• Savings account – $30,000
• Total – $45,000

But knowing that you have $45,000 doesn’t tell us the whole story.

You also have obligations:

• Car loan – $18,000
• Credit card – $4,000
• Total – $22,000

So while you have $45,000, you also owe $22,000. That leaves: $45,000 − $22,000 = $23,000

That $23,000 represents your net financial position in this simplified example.

An HOA Balance Sheet follows essentially the same logic.

The terminology is just different.

Every Balance Sheet is built around three major categories:

What the association has or is owed

• Operating cash
• Reserve cash
• Accounts receivable
• Prepaid expenses
• Other assets

What the association owes or is obligated to provide

• Unpaid vendor bills
• Accounts payable
• Accrued expenses
• Loans
• Security deposits
• Assessments received in advance

The association’s accumulated financial position

In very simple terms: What’s left after liabilities are subtracted from assets.

That gives us the fundamental Balance Sheet equation:

ASSETS = LIABILITIES + FUND BALANCE

Or looked at another way:

ASSETS − LIABILITIES = FUND BALANCE

This is one of the most common misunderstandings when reading HOA financial statements.

No.

Fund Balance is not a bank account.

Fund Balance represents the association’s overall accumulated financial position – not simply the amount sitting in a bank account.

Suppose you have:

$20,000 in your bank account.

Does that mean your net worth is $20,000?

Not necessarily.

Maybe you also have:

$15,000 car loan

and

$3,000 credit-card balance.

Your bank balance tells you how much cash you have.

It doesn’t tell you your complete financial position.

The same principle applies to an HOA.

CASH ≠ FUND BALANCE

They are related, but they are not the same thing.

When reviewing the Balance Sheet, don’t just look at the total at the bottom.

Start asking questions.

1. CASH
   • Do we have enough operating cash to comfortably pay upcoming bills?
   • Are reserve funds properly separated?
2. ACCOUNTS RECEIVABLE
   • How much money do homeowners owe the association?
   • Is that number increasing?
   • How old are those balances?
3. LIABILITIES
   • How much does the association currently owe?
   • Are vendor invoices being paid on time?
   • Are there significant accrued expenses or loans?
4. FUND BALANCE
   • Is the operating fund balance healthy?
   • Has it been increasing or decreasing?
   • Are operating deficits accumulating?
5. RESERVES
   • How much has been accumulated?
   • Are reserve balances consistent with the association’s reserve funding plan and applicable requirements?

The Balance Sheet gave us a snapshot of the association’s financial position at one specific moment.

The Income Statement tells a different story. It answers:

“What happened financially during the month, quarter, or year?”

It shows the association’s revenue and expenses over a period of time and whether revenue exceeded expenses—or expenses exceeded revenue.

Depending on the accounting system or report package, you may also see this report called a:

• Statement of Income and Expenses
• Profit & Loss Statement (P&L)
• Statement of Revenues and Expenses

The names may differ, but the basic purpose is the same.

This is where HOA accounting can become confusing.

An HOA is generally organized and operated as a not-for-profit association.

That does not mean revenue and expenses must equal exactly zero every year.

And it does not mean the association is prohibited from ending a year with more revenue than expenses.

Not-for-profit does not mean “no surplus.”

An HOA can experience something similar.

A traditional for-profit business generally exists to generate profits for its owners or shareholders.

An HOA exists for a different purpose:

To collect funds from its members and use those funds to operate, maintain and preserve the community.

SURPLUS – Revenue exceeded expenses or DEFICIT – Expenses exceeded revenue.

Ultimately, the association has to absorb that shortfall somehow.

Depending on the circumstances, it could contribute to:

1. Reduced operating cash
2. A lower operating fund balance
3. Deferred expenses
4. Future assessment increases
5. Special assessments
6. Other corrective action

A deficit isn’t automatically evidence of poor management.

An unexpected insurance increase, emergency repair, legal expense, or other unusual event could cause one.

But recurring deficits deserve attention.

Imagine your personal expenses look like this:

January: $5,000
February: $5,200
March: $9,500

Is March automatically a problem?

Not necessarily.

Maybe your annual homeowners or auto insurance premium was paid in March.

Maybe you replaced your air conditioner.

Maybe you had an unusual one-time expense.

HOA expenses can behave the same way.

Insurance, major repairs, legal expenses, seasonal utilities, contracts and other costs may not occur evenly every month.

That’s why board members should look at both: The Current Period and The Year-to-Date Results before drawing conclusions.

Revenue tells us what was earned or recognized under the accounting method being used.

Cash tells us what actually entered the bank account.

They are not always the same thing.

We’ll explore this much more when we discuss Cash vs. Accrual Accounting.

REVENUE ≠ CASH

This distinction becomes extremely important when trying to understand why the Income Statement and bank balance don’t appear to tell exactly the same story.

EXPENSE ≠ CASH PAYMENT

When reviewing the Income Statement, don’t simply look at whether the bottom number is positive or negative. Ask:

1. REVENUE
   • Are assessments being recorded as expected?
   • Are other revenue sources consistent with expectations?
   • Are there unusual changes?
2. EXPENSES
   • Which expenses are significantly higher than normal?
   • Are there unexpected costs?
   • Are certain expenses increasing consistently?
3. SURPLUS / DEFICIT
   • Is the association operating above or below its planned level?
   • Is the difference temporary or recurring?
4. TRENDS
   • How does this month compare with previous months?
   • How does year-to-date performance compare with last year?

In the last chapter, we learned that the Income Statement tells us what actually happened.

But knowing what happened isn’t enough. That’s where the budget comes in.

Suppose your association spent $45,000 on landscaping this year.

Was that good?

Was it bad?

We can’t answer that question until we know what the association planned to spend.

That’s where the budget comes in.

THE BUDGET = THE PLAN

ACTUAL = WHAT REALLY HAPPENED

VARIANCE = THE DIFFERENCE BETWEEN THE TWO

A Budget vs. Actual report puts those numbers together so the board can see where reality differed from the plan.

Imagine your household creates the following plan for the month:

YOUR PLAN

Housing
$2,500

Groceries
$800

Utilities
$400

Entertainment
$500

You reach the end of the month and look at what actually happened.

Your grocery spending wasn’t $800.

It was: $1,050

You planned to spend $800, but actually spent $1,050.

The difference is: $250 OVER BUDGET

That’s a variance.

But the variance itself isn’t really the important part.

The important question is: WHY?

Maybe food prices increased.

Maybe you hosted a family gathering.

Maybe you simply spent more than expected.

The numbers identify the difference.

Understanding the reason behind the difference is where financial management begins.

This is important.

Board members sometimes see a negative variance and immediately assume something went wrong.

That’s not always true.

To help the board understand, ask:

• What changed
• Why did it change
• Is it temporary or recurring
• Do we need to do something about it

It’s easy to think of an HOA budget as simply: “How much are we allowed to spend?”

But the budget serves a much larger purpose. It estimates:

How much the association expects to spend

which helps determine:

How much money the association needs to collect

Imagine your household expects next year’s expenses to be:

$72,000

That’s approximately:

$6,000 PER MONTH

But your household income is only:

$5,000 PER MONTH

You have a problem before the year even begins.

Your expected expenses exceed your expected income by:

$12,000 PER YEAR

You would need to make a decision.

Earn more.

Spend less.

Use savings.

Delay something.

Or change your financial plan.

An HOA faces similar choices.

If expected operating expenses are consistently higher than expected revenue, the association eventually has to address that imbalance.

The budget isn’t something the board should approve once and forget about until next year.

It should be used as a management tool throughout the year.

Each month, the board should be able to compare:

WHAT WE PLANNED

against

WHAT ACTUALLY HAPPENED

and then ask:

WHAT CHANGED?

That gives the board time to react.

If insurance is trending higher than expected in March, the board can see it.

If water expenses begin increasing in May, the board can investigate.

If legal expenses are significantly over budget by July, the board can understand the impact before December arrives.

The earlier a meaningful trend is identified, the more time the board has to respond.

When reviewing Budget vs. Actual, focus first on the items that are meaningfully different from the plan.

1. LARGE VARIANCES
   • Which accounts are significantly over or under budget?
2. RECURRING VARIANCES
   • Is the same expense exceeding budget month after month?
3. UNEXPECTED EXPENSES
   • Did something happen that wasn’t included in the original budget?
4. TIMING DIFFERENCES
   • Is this a real variance, or did an annual or seasonal expense simply occur earlier than expected?
5. DEFERRED WORK
   • Are we under budget because we saved money—or because necessary work hasn’t been completed?

Remember what we’ve already learned:

REVENUE ≠ CASH RECEIVED

and

EXPENSE ≠ CASH PAID

Money can also move between accounts, owners may still owe assessments, bills may remain unpaid, and transactions can affect cash without appearing as ordinary operating revenue or expenses.

So far, we’ve learned:

The Balance Sheet tells us where we stand.

The Income Statement tells us what happened.

Budget vs. Actual tells us how reality compared with our plan.

But there’s still another question:

WHERE DID THE ACTUAL CASH GO?

So far, we’ve looked at three different views of the association’s finances:

The Balance Sheet tells us where we stand.

The Income Statement tells us what happened.

Budget vs. Actual tells us whether what happened matched the plan.

But board members often have another, much more practical question:

“Where did the money actually go?”

That’s a cash flow question.

And it’s important because:

PROFIT OR SURPLUS ≠ CASH

An association can report a surplus on its Income Statement while its bank balance actually decreases.

It sounds contradictory.

It isn’t.

Imagine you earn:

$8,000 THIS MONTH

and your normal household expenses are:

$6,500

On paper, you’re ahead:

$1,500

But this month you also decide to pay:

$5,000

toward the principal balance of your car loan.

At the end of the month, your bank account has actually decreased.

Why?

Because paying down the principal of a loan uses cash, but the principal payment itself isn’t the same thing as an ordinary monthly expense on an accrual-based Income Statement.

You used cash to reduce something you owed.

Your financial position changed.

But that movement doesn’t necessarily appear on the Income Statement the way groceries, utilities, or insurance would.

That’s why looking only at income and expenses doesn’t always explain what happened to cash.

This is one of the most important concepts in HOA accounting.

Imagine Palm Grove receives a $10,000 vendor invoice.

Depending on the accounting basis and timing:

WHEN THE EXPENSE IS RECORDED

The Income Statement may show:

Repairs Expense +$10,000

while the Balance Sheet shows:

Accounts Payable +$10,000

But cash hasn’t moved yet.

Later, when Palm Grove actually pays the invoice:

Cash decreases $10,000

Accounts Payable decreases $10,000

But there isn’t necessarily another $10,000 expense.

It’s the same transaction moving through different stages.

Your personal credit card provides an easy comparison.

Suppose you buy:

$1,000 OF FURNITURE

using your credit card.

You now have the furniture and you owe the credit-card company $1,000.

But your checking account hasn’t changed.

Later, when you pay the credit-card bill:

Your checking account decreases by $1,000.

You didn’t buy the furniture again.

You’re simply paying an obligation that already existed.

An HOA’s Accounts Payable can work in a similar way.

Here’s another example.

Suppose your association transfers:

$25,000

from its operating bank account to its reserve bank account.

What happened?

Operating cash went down.

Reserve cash went up.

But did your association suddenly incur a $25,000 operating expense simply because money moved between its own bank accounts?

No.

The association moved cash from one place to another.

This is why looking at one bank account by itself can sometimes create the wrong impression.

The money may not be gone.

It may simply be somewhere else.

CASH MOVEMENT ≠ EXPENSE

Board members naturally look at the bank account.

That’s important.

But the bank balance answers only one question:

“How much cash is in this account right now?”

It doesn’t necessarily tell you:

• How much homeowners still owe.
• How many unpaid vendor bills exist.
• How much cash belongs to reserves.
• How much revenue has been earned.
• How much expense has been incurred but not yet paid.
• Whether assessments were collected in advance.
• Whether the association is operating above or below budget.

That’s why financial statements exist alongside bank statements.

When the Income Statement and bank balance seem to tell different stories, don’t assume something is wrong.

Start looking for the bridge between them. Ask:

1. DID RECEIVABLES INCREASE?
   • The association may have recorded revenue that hasn’t been collected yet.
2. DID ACCOUNTS PAYABLE DECREASE?
   • The association may have used cash to pay expenses recorded in an earlier period.
3. DID WE TRANSFER MONEY?
   • Cash may have moved between operating and reserve accounts.
4. DID WE PAY DOWN DEBT?
   • Cash may have been used to reduce a liability.
5. DID OWNERS PAY IN ADVANCE?
   • Cash may have arrived before the associated revenue was recognized.
6. DID WE PURCHASE OR FUND SOMETHING OUTSIDE NORMAL OPERATIONS?
   • Not every use of cash appears as a regular operating expense.

There’s a simple way to remember the difference.

BALANCE SHEET – Where are we?

INCOME STATEMENT – What did we earn and incur?

BUDGET VS. ACTUAL – How did reality compare with the plan?

CASH FLOW – “WHERE DID THE CASH COME FROM, AND WHERE DID IT GO?”

Each report answers a different question.

Together, they tell a much more complete story.

When reviewing cash, don’t focus only on whether the bank balance increased or decreased. Ask:

• OPERATING CASH
  • Do we have enough cash available to pay normal upcoming obligations?
• COLLECTIONS
  • Are homeowners paying assessments on time?
  • Is Accounts Receivable increasing?
• PAYABLES
  • Are we paying vendors normally, or is cash appearing artificially high because bills haven’t been paid?
• TRANSFERS
  • Has money moved between operating and reserve accounts?
• DEBT
  • Did we use cash to reduce loans or other liabilities?
• TIMING
  • Are there significant differences between when revenue or expenses are recorded and when cash actually moves?

The goal isn’t simply to know the bank balance.

The goal is to understand:

WHY THE BANK BALANCE IS WHAT IT IS.

We’ve established that an association can have a significant amount of cash in the bank without having all of that money available for everyday expenses.

Why?

Because not all HOA money serves the same purpose.

At the simplest level, think about association funds as belonging to two different financial needs:

OPERATING FUNDS – Money used to run the community today.

and

RESERVE FUNDS – Money accumulated for major repair and replacement needs tomorrow.

Understanding the difference is critical when evaluating an association’s financial health.

Imagine you have:

CHECKING ACCOUNT – $8,000

and

SAVINGS ACCOUNT – $40,000

Your total cash is: $48,000

Does that mean you should feel comfortable spending $48,000 on your normal monthly bills?

Probably not.

Perhaps that $40,000 savings account has a purpose.

Maybe:

• $20,000 is being saved for a future home repair.
• $10,000 is your emergency fund.
• $10,000 is being saved to replace your car.

Technically, you have $48,000 in cash.

But psychologically and financially, you don’t think of all $48,000 as: “Money available to spend this month.”

An HOA faces a similar distinction.

Operating funds are used for the association’s normal recurring expenses.

Think about everything required to keep a community functioning.

• Insurance
• Landscaping
• Utilities
• Management
• Janitorial services
• Pest control
• Routine repairs
• Accounting
• Legal services
• Pool maintenance

These are the association’s everyday costs of doing business.

Owners’ regular assessments generally provide the funding needed to pay these expenses.

Think of operating cash like your household checking account.

Money comes in.

Normal bills get paid.

And the association needs enough liquidity to continue operating comfortably.

Some association expenses don’t happen every month.

They may not even happen every year.

But eventually, they happen.

A roof wears out.

A parking lot needs resurfacing.

A building needs painting.

An elevator reaches the end of its useful life.

Major equipment needs replacement.

These projects can cost tens or hundreds of thousands of dollars.

Instead of waiting until the day a major component fails and asking owners for the entire amount at once, associations may accumulate money over time.

Those accumulated funds are:

RESERVES – Think of reserves as long-term savings for predictable major expenses.

Suppose your car is running perfectly today.

No warning lights.

No strange noises.

No problems.

Does that mean your future automobile expense is:

$0?

Of course not.

Eventually you’ll need:

Tires.

Brakes.

A battery.

Major maintenance.

And eventually, perhaps another vehicle.

Those expenses haven’t happened yet.

But you know they’re coming.

Imagine you expect to need:

$1,200 FOR TIRES

in approximately four years.

Instead of waiting four years and suddenly needing $1,200, you could save:

$25 PER MONTH

After four years:

$25 × 48 MONTHS = $1,200

When the tires eventually need replacement, the money is already there.

That’s the basic financial concept behind reserves.

Your association knows its roof will eventually need replacement.

Suppose the estimated future replacement cost is:

$600,000

and, for a simplified illustration, the association expects replacement in:

10 YEARS

If Palm Grove waits until Year 10 to think about the roof, it could suddenly face a massive funding problem.

Instead, the association can accumulate funds over time toward that future obligation.

The same concept may apply to other major components.

• Parking areas
• Painting
• Elevators
• Pool equipment
• Structural components
• Mechanical systems
• Other long-lived association assets

This is why reserve planning is so important.

You may hear people say: “Our reserves are fully funded.”

That phrase can be misunderstood.

It doesn’t necessarily mean the association already has enough cash sitting in the bank today to replace every reserve component immediately.

Reserve funding generally considers factors such as:

• Estimated replacement cost
• Remaining useful life
• Current reserve balance
• Expected future contributions
• and other assumptions used in the association’s reserve analysis.

The purpose is to develop a funding plan for future obligations—not necessarily to hold the full future replacement cost of every component in cash today.

Suppose Palm Grove eventually replaces a major component using properly available reserve funds.

Cash leaves the reserve account to pay for the project.

But that doesn’t mean the association suddenly failed financially.

This is what the reserve money was accumulated for.

Saving the money was part of the plan.

Eventually spending the money for its intended purpose is also part of the plan.

A declining reserve bank balance isn’t automatically bad if the decrease resulted from a planned, properly funded project.

Again:

CONTEXT MATTERS.

When reviewing operating and reserve funds, ask:

• OPERATING CASH
  • Do we have enough liquidity to comfortably pay normal bills?
• OPERATING RESULTS
  • Are regular operations consistently producing deficits?
• RESERVE CASH
  • How much has actually been accumulated?
• RESERVE PLAN
  • What major projects are expected in the future?
• FUNDING
  • Are current contributions consistent with the association’s reserve funding requirements and plan?
• UPCOMING PROJECTS
  • Are significant reserve expenditures approaching?
• USE OF FUNDS
  • Are reserve funds being used and accounted for appropriately?

Some of the most important numbers on an HOA’s Balance Sheet represent money that hasn’t actually changed hands yet.

Homeowners may owe money to the association.

The association may owe money to vendors.

Those two concepts have very similar names:

ACCOUNTS RECEIVABLE – Money others owe the association.

and

ACCOUNTS PAYABLE – Money the association owes others.

An easy way to remember the difference:

RECEIVABLE = WE EXPECT TO RECEIVE IT

PAYABLE = WE NEED TO PAY IT

Imagine you lend a friend:

$500

Your checking account decreases by $500.

But did the money simply disappear?

Not exactly.

Your friend now owes you:

$500

You have something of financial value:

MONEY YOU EXPECT TO RECEIVE.

That’s similar to an Accounts Receivable.

Now imagine you use your credit card to buy:

$1,000

of furniture.

You haven’t paid the credit-card company yet.

But you now owe:

$1,000

That’s similar to an Accounts Payable.

One represents money expected to come in.

The other represents money expected to go out.

Your association charges homeowners:

$500 PER MONTH

in regular assessments.

Suppose an owner’s January assessment becomes due:

$500

but the owner doesn’t pay it.

Depending on the association’s accounting basis, Palm Grove may still record the assessment revenue.

But instead of receiving cash, your association records:

ACCOUNTS RECEIVABLE – $500

In plain English:

The association earned or charged the amount, but hasn’t collected the money yet.

Remember our rule from Chapter 03:

REVENUE ≠ CASH

This is a perfect example.

Your association may show:

ASSESSMENT REVENUE – $50,000

for the month.

But suppose owners actually paid only:

$47,000

The remaining:

$3,000

may become Accounts Receivable.

The Income Statement can therefore show $50,000 of assessment revenue while the bank account received only $47,000.

Nothing is necessarily wrong with the accounting.

The association simply hasn’t collected all of the money yet.

Accounts Receivable appears in the Asset section of the Balance Sheet.

That can seem strange.

How can money you don’t have be considered an asset?

Because the association has a financial claim to money that is owed to it.

But there’s an important practical distinction:

$25,000 CASH

and

$25,000 ACCOUNTS RECEIVABLE

are not equally useful when the electric bill is due tomorrow.

The electric company generally wants cash.

Not a list of homeowners who owe you money.

That’s why a board should never look at Total Assets without understanding what those assets actually consist of.

Imagine three friends each owe you $500.

FRIEND #1 – Borrowed $500 yesterday.

FRIEND #2 – Borrowed $500 three months ago.

FRIEND #3 – Borrowed $500 two years ago and has stopped answering your calls.

Technically, all three owe you:

$500

But would you view all three debts the same way?

Probably not.

The older a receivable becomes, the more attention it generally deserves.

HOA receivables work similarly.

Now imagine Palm Grove experiences both problems simultaneously.

Homeowners owe $40,000

while your association owes vendors $35,000

The association is caught in the middle.

Money isn’t arriving as quickly as expected.

But bills still need to be paid.

That’s a classic cash-flow pressure.

MONEY COMING IN TOO SLOWLY combined with MONEY THAT STILL NEEDS TO GO OUT.

This is why collections and vendor obligations deserve regular board attention.

Another concept boards should understand is that recording a receivable doesn’t guarantee the association will ultimately collect every dollar.

Some balances may become difficult to collect.

Circumstances involving foreclosures, bankruptcies, disputes, ownership changes, or other collection issues can affect recovery.

Accounting may therefore sometimes include an:

ALLOWANCE FOR DOUBTFUL ACCOUNTS

or other adjustments related to expected collectibility.

You don’t need to become an accountant to understand the underlying principle:

MONEY OWED TO YOU IS NOT THE SAME AS MONEY ALREADY IN YOUR BANK ACCOUNT.

When reviewing Accounts Receivable, ask:

• TOTAL RECEIVABLES
  • How much money is currently owed to the association?
• AGE
  • How much has been outstanding for 30, 60, 90 or more days?
• TREND
  • Are receivables increasing or decreasing?
• CONCENTRATION
  • Are many owners slightly behind, or are a small number responsible for most of the balance?
• COLLECTION ACTIVITY
  • Are delinquent accounts being handled consistently under the association’s collection procedures and applicable requirements?

When reviewing Accounts Payable, ask:

• TOTAL PAYABLES
  • How much does the association currently owe vendors and others?
• AGE
  • Are invoices being paid within normal terms?
• UNUSUAL BALANCES
  • Are there old or unusually large unpaid invoices?
• CASH FLOW
  • Does the association have sufficient operating cash to satisfy upcoming obligations?
• TREND
  • Are payables increasing month after month?

Throughout this guide, we’ve repeatedly seen situations where:

REVENUE ≠ CASH RECEIVED

and

EXPENSE ≠ CASH PAID

Why?

Because accounting isn’t only concerned with when money moves.

It can also be concerned with when revenue is earned and when expenses are incurred.

That brings us to two important accounting methods:

CASH BASIS

and

ACCRUAL BASIS

The difference is largely about: TIMING.

Imagine you manage your personal finances by looking only at your checking account.

When your paycheck arrives:

You record income.

When you pay your electric bill:

You record an expense.

When nothing enters or leaves the bank:

You record nothing.

That’s essentially the logic behind:

CASH-BASIS ACCOUNTING

Transactions are generally recognized when cash is actually received or paid.

Simple.

Intuitive.

And very similar to how many people naturally think about their personal finances.

Now imagine your electric company provides electricity throughout December.

On December 31, you’ve already used:

$500 OF ELECTRICITY

But the bill doesn’t arrive until January.

Did the December electricity really cost you nothing?

Of course not.

You consumed $500 of electricity in December.

You simply haven’t paid for it yet.

Accrual accounting tries to reflect that economic reality.

Under:

ACCRUAL ACCOUNTING

the expense is generally recognized when it is incurred, not simply when the cash is eventually paid.

So the December financial statements may recognize:

ELECTRICITY EXPENSE – $500

and

AMOUNT OWED – $500

even though the checking account hasn’t changed yet.

Suppose you work the final two weeks of December.

You earned:

$3,000

But your employer doesn’t deposit the paycheck until January 5.

Which month did you actually perform the work?

DECEMBER.

Cash basis focuses primarily on when the money arrived.

Accrual accounting focuses on the period in which the underlying financial activity occurred.

That’s the conceptual difference.

Imagine you pay: $1,200

today for 12 months of auto insurance.

Your bank account immediately decreases: $1,200

But did you consume all 12 months of insurance today?

No.

You’ve paid in advance for coverage you’ll receive over the coming year.

That’s why:

CASH PAID ≠ EXPENSE INCURRED

The payment and the expense can happen at different times.

This one can feel backwards.

Your association receives cash.

Cash is an asset.

So why would prepaid assessments also create a liability?

Think about buying a:

$600 GIFT CARD

from a store.

The store receives your $600 today.

But it still owes you something:

$600 WORTH OF FUTURE GOODS OR SERVICES.

Until that obligation is satisfied, receiving the cash doesn’t necessarily mean the entire amount has been earned as current revenue.

The same general accounting concept helps explain prepaid assessments.

The association has received money relating to a future period.

Imagine your association waits to record every expense until the check is actually written.

A board could delay paying invoices near the end of the month.

Suddenly, that month’s expenses would appear lower.

But did the association actually avoid those costs?

No.

The bills still exist.

Accrual accounting helps prevent the financial statements from being driven solely by the timing of checks and deposits.

Instead, the goal is to show financial activity in the period where it economically belongs.

You don’t need to prepare accrual entries yourself.

But you should understand what they mean.

When reviewing financial statements, ask:

• RECEIVABLES
  • Are we recognizing revenue that hasn’t yet been collected?
• PAYABLES
  • Are there expenses we’ve incurred but haven’t paid?
• PREPAID EXPENSES
  • Have we paid for significant services that cover future periods?
• PREPAID ASSESSMENTS
  • Have owners paid assessments relating to future periods?
• MONTH-END / YEAR-END
  • Are significant expenses and revenues appearing in the correct accounting periods?
• CASH
  • How does our actual cash position compare with what the financial statements appear to show?

These questions help explain why the numbers on an Income Statement don’t always match the movement in the bank account.

This is one of the most common misunderstandings about association finances:

“We’re a nonprofit. Aren’t we supposed to break even?”

Not exactly.

Being organized and operated as a not-for-profit association does not mean the association’s revenue and expenses must equal exactly zero every month or every year.

It also doesn’t mean the association shouldn’t accumulate funds.

The important distinction is:

WHY DOES THE ORGANIZATION EXIST?

Imagine a company sells: $1,000,000

of products during the year.

After paying its expenses, it has: $150,000

remaining.

A traditional for-profit company generally exists to generate economic returns for its owners or shareholders.

That $150,000 may ultimately benefit those owners through distributions, retained earnings that increase business value, reinvestment in the company, or other means.

Generating profit is part of the reason the business exists.

Your association isn’t selling a product to generate returns for shareholders.

It exists to:

• Maintain the community
• Pay common expenses
• Insure the property
• Maintain common elements
• Fund future repair and replacement needs
• Administer association operations
• And fulfill its responsibilities to the community

Owners provide the money necessary to accomplish those purposes.

THE HOA’S PURPOSE ISN’T TO GENERATE PROFITS FOR INVESTORS.

It’s to operate and maintain the association for its members.

That is the fundamental distinction.

Your household isn’t a for-profit company either.

Suppose your family earns: $8,000 and spends: $7,500; That leaves: $500

Would you say: “Something went wrong. Our household made a profit.”

Probably not.

You simply spent less than you earned.

That $500 might remain in checking.

It might go into savings.

It might help cover a future expense.

Or it might provide a cushion for an unexpected bill.

Having money left over doesn’t suddenly turn your household into a for-profit business.

An HOA can similarly end a period with revenue exceeding expenses.

Suppose you want to minimize what your car costs this year.

You decide:

Don’t change the oil.

Don’t replace worn tires.

Ignore the brakes.

Skip scheduled maintenance.

Your annual car expenses look fantastic.

You “saved” a lot of money.

But did you actually improve your financial position?

Probably not.

You deferred costs and potentially created larger future problems.

An association can do the same thing.

Keeping expenses artificially low by postponing necessary maintenance doesn’t necessarily create real savings.

Sometimes it simply moves the expense into the future.

Suppose your association ends the year with: $30,000 EXCESS REVENUE OVER EXPENSES.

What happens to it?

It doesn’t disappear simply because the year ended.

The association’s operating results ultimately affect its overall financial position.

Remember our simplified relationship from the Income Statement chapter:

BEGINNING FUND BALANCE $68,000

plus

CURRENT-YEAR SURPLUS $30,000

equals:

ENDING FUND BALANCE $98,000

This is one of the ways the Income Statement connects back to the Balance Sheet.

Another misconception is: “We’re nonprofit, so shouldn’t we spend whatever is left before the end of the year?”

No.

An association doesn’t need to intentionally spend money simply to make revenue and expenses equal exactly zero.

Spending money unnecessarily doesn’t improve the association’s financial health.

The board’s responsibility is to manage association resources appropriately—not to eliminate every dollar of annual surplus for the sake of reaching zero.

When reviewing the association’s annual operating results, ask:

• SURPLUS OR DEFICIT
  • What was the result for the period?
• REASON
  • What caused it?
• RECURRING OR ONE-TIME
  • Is this an unusual event or an ongoing trend?
• OPERATING HEALTH
  • Are regular assessments sufficient to support normal operating expenses?
• DEFERRED EXPENSES
  • Did we actually save money, or did we postpone necessary work?
• FUND BALANCE
  • How are annual operating results affecting the association’s accumulated financial position?
• FUTURE NEEDS
  • Are today’s financial decisions creating problems for future owners?

You’ve made it through the individual pieces.

Now it’s time to put them together.

Because the real value of financial statements isn’t understanding one number.

It’s understanding:

THE STORY THE NUMBERS ARE TELLING TOGETHER.

A Balance Sheet might look perfectly reasonable by itself.

An Income Statement might show a surplus.

The bank account might contain plenty of cash.

But when you connect those numbers with receivables, payables, reserves and the budget, the story can change completely.

When you receive a monthly financial package, don’t treat every report as a separate document.

Read them together.

1. CASH

• How much operating cash do we have?
• Is it increasing or decreasing?

2. RECEIVABLES

• How much do owners owe us?
• Is the balance growing?

3. PAYABLES

• How much do we owe?
• Are bills being paid normally?

4. INCOME STATEMENT

• Did revenue exceed expenses?
• Were there unusual items?

5. BUDGET VS. ACTUAL

• Where are the meaningful variances?
• Why did they happen?

6. RESERVES

• Are contributions being made?
• What projects are approaching?
• Are reserve funds being used appropriately?

7. TRENDS

• How does all of this compare with:
  • Last month?
  • Three months ago?
  • The beginning of the year?
  • Last year?
  • The budget?

A single month is a photograph.

TRENDS TURN THOSE PHOTOGRAPHS INTO A MOVIE.

Board members shouldn’t need an accounting degree to understand the financial condition of their community.

A useful financial package should make it easier to understand:

• WHAT WE HAVE
• WHAT WE OWE
• WHAT OWNERS OWE US
• WHAT WE EARNED
• WHAT WE SPENT
• HOW WE COMPARE TO BUDGET
• HOW MUCH CASH IS AVAILABLE
• HOW MUCH IS SET ASIDE FOR THE FUTURE
• AND WHERE THE ASSOCIATION APPEARS TO BE HEADED

If the board understands those things, it can make much better financial decisions.

Financial statements aren’t simply reports your association is supposed to receive and file away.

They’re management tools.

When you understand how the Balance Sheet, Income Statement, budget, cash, receivables, payables and reserves connect, the numbers stop looking like isolated accounting data.

They begin telling you:

THE FINANCIAL STORY OF YOUR COMMUNITY.

Florida community associations generally fall under one of three primary statutory chapters:

• CHAPTER 718 Florida Condominium Act

• CHAPTER 719 Florida Cooperative Act

• CHAPTER 720 Florida Homeowners’ Association Act

These laws share many financial concepts, but they are not identical.

A requirement that applies to a condominium under Chapter 718 does not automatically apply to an HOA governed by Chapter 720.

Not every Florida association automatically requires an annual audit.

The required level of financial reporting generally depends on the association’s total annual revenue, although additional rules and exceptions can apply.

For Chapters 718, 719 and 720, the general revenue thresholds currently follow the same basic structure.

• LESS THAN $150,000
  • REPORT OF CASH RECEIPTS AND EXPENDITURES
• $150,000 TO LESS THAN $300,000
  • COMPILED FINANCIAL STATEMENTS
• $300,000 TO LESS THAN $500,000
  • REVIEWED FINANCIAL STATEMENTS
• $500,000 OR MORE
  • AUDITED FINANCIAL STATEMENTS

So when someone asks: “Does our association need an audit?”

the first question is often: “What is your revenue?”

There are important exceptions, waiver provisions and association-specific requirements, so the revenue threshold should be treated as the starting point—not the end of the analysis.

These terms are sometimes used interchangeably by board members.

They shouldn’t be.

• COMPILATION
  • A CPA assists in presenting the association’s financial information in financial-statement form.
  • It provides substantially less assurance than a review or audit.
• REVIEW
  • A CPA performs analytical procedures and inquiries designed to provide limited assurance regarding the financial statements.
  • It involves more work than a compilation but substantially less than an audit.
• AUDIT
  • An audit involves substantially more extensive procedures and provides the highest level of assurance of these three services.
  • The CPA examines evidence supporting financial statement amounts and disclosures and performs other procedures necessary to express an audit opinion.

MORE ASSURANCE GENERALLY MEANS MORE WORK, MORE DOCUMENTATION AND MORE COST.

Florida law establishes deadlines surrounding annual financial reporting.

For associations governed by these statutes, the annual financial report generally must be completed and made available to members within the applicable statutory timeframe.

A useful number for board members to remember is:

120 DAYS

after the end of the association’s fiscal year, subject to the specific statute and applicable requirements.

Once the final report is completed or received, additional timing requirements can apply regarding providing the report—or notice of its availability—to members.

This is something the board, manager, bookkeeper and CPA should calendar every year.

Certain Florida condominium and cooperative buildings are subject to additional requirements involving a:

STRUCTURAL INTEGRITY RESERVE STUDY OR SIRS

A SIRS is not simply a traditional financial reserve study.

It addresses specified building components and evaluates matters including their remaining useful life and estimated replacement or deferred-maintenance costs, as required by applicable Florida law.

Florida’s SIRS requirements have changed significantly in recent years and depend on factors such as the building and association involved.

For that reason, a board should never assume: “We had a reserve study done a few years ago, so we’re covered.”

The board should determine whether its association is subject to current SIRS requirements and whether the study and funding comply with current law.

This surprises many board members.

YES.

Being a not-for-profit association does not automatically mean the association never files or pays federal income tax.

Many community associations file their federal tax return using either:

FORM 1120 – U.S. Corporation Income Tax Return

or

FORM 1120-H – U.S. Income Tax Return for Homeowners Associations.

Which method is more advantageous depends on the association’s particular financial circumstances.

This is probably the rule you’ve heard about.

To qualify for the federal tax treatment available under Section 528 / Form 1120-H, an association must satisfy several requirements.

Two important tests are:

AT LEAST 60%

of the association’s gross income must generally consist of qualifying exempt-function income.

Think primarily of qualifying amounts received from members in their capacity as owners, such as assessments, subject to the applicable federal rules.

and

AT LEAST 90%

of the association’s expenditures must generally be for qualifying purposes involving the acquisition, construction, management, maintenance and care of association property.

So the shorthand is:

60% INCOME TEST/90% EXPENDITURE TEST

All of these requirements depend on one thing:

The association should be able to support its financial activity with appropriate records.

That commonly includes items such as:

• Bank statements
• Bank reconciliations
• General ledgers
• Invoices
• Contracts
• Receipts
• Owner ledgers
• Accounts Receivable reports
• Accounts Payable records
• Financial statements
• Budgets
• Reserve records
• Tax returns
• CPA reports
• And other supporting financial documentation

Florida law also establishes official-record requirements and retention periods that vary by the type of record and association.

Florida law tells associations many things they must do.

But good financial management goes beyond minimum statutory compliance.

A well-managed association should also maintain appropriate internal controls.

• BANK RECONCILIATIONS
  • Bills should have a clear review and approval process before payment.
• SEGREGATION OF DUTIES
  • When practical, one individual should not control every step of receiving money, recording transactions, approving payments and reconciling the bank account.
• RESERVE CONTROLS
  • Reserve accounts and transfers should be clearly identified, documented and appropriately authorized.
• COLLECTION MONITORING
  • Delinquent owner balances should be regularly reviewed and handled consistently with the association’s collection policy and applicable law.
• MONTHLY FINANCIAL REVIEW
  • Boards should actually review their financial statements—not simply receive them.