Balancing the Bottom Line Understanding Your Building's Finances

 Not everybody on a co-op or condo's board is an accountant (or can even balance  their own checkbook, for that matter.) No doubt, handling large amounts of money for an entire building is a huge  responsibility. Residents, therefore, rely upon their board to make good  financial decisions on behalf of the entire community in an effort to protect  its individual and collective assets.  

 Although the terminology is different, and the dollar amounts and orders are of  a much larger magnitude, at a fundamental level, managing the finances of a  building is not so very different from managing your own finances. What is  prudent for the latter is prudent for the former, and the mistakes people make  managing their own money—using credit cards to pay for fixed expenses, for example—are the same ones board members often make.  

 Here are some financial basics, as well as a few common mistakes boards make  when dealing with their proverbial pocketbooks—and how your board can avoid them.  

 What Am I Looking At?

 "The financial statements of a co-op or condo contain the same basic information  as that of a commercial business," says Carl Cesarano of the Manhattan-based  accounting firm Cesarano & Khan, P.C. "The statements include the balance sheet, statement of revenues,  expenses and accumulated surplus or deficit—also known as retained earnings—statement of cash flows, and notes to the financial statements. Building boards  should use these financial statements in conjunction with a well-organized  management report."  

 According to Cesarano:

 A balance sheet reports assets, liabilities and the difference between the two,  which is referred to as stockholders’ equity (condos use the term "fund balance" or "members’ equity"). Assets are presented in order of liquidity, and liabilities are  presented in order of maturity.  

 The statement of revenues, expenses and accumulated surplus or deficit reports  present information about revenues (maintenance or common charges, special  assessments, interest income, administrative fees, etc.) and expenses (wages,  real estate professional fees, taxes, etc.) The statement of revenues and  expenses should also report the excess or deficiency of revenues over expenses  for the period as well as a reconciliation of beginning and ending accumulated  surplus or deficit with results of operations for the period.  

 The statement of cash flows is a reconciliation of the balance of cash at the  beginning of the year to the balance at the end of the year. It provides an  analysis of the excess or deficiency of revenues over expenses to cash flows  operating, investing and financing activities. In short, it measures changes in  the balance sheet, as well as the bottom line from operations to account for  the change in the entity’s cash balance from one year to the next.  

 The notes to the financial statements provide additional explanations to certain  line items on the financial statements as required by Generally Accepted  Accounting Principles (GAAP). Some that are required by disclosures include the  organization or legal form (corporation or association) of the entity, the  location and number of units, summary of significant accounting policies,  restrictions on cash or other assets, the components of property and equipment,  mortgage information (including pledged assets), commitments and contingencies,  and income tax filing status (including income tax liabilities and credits.)  

 In Must Be Greater Than Out

 In the plainest possible terms for a layman to understand, the amount of money  coming into a building community's coffers must exceed the amount of money  going out. The concept couldn’t be easier to grasp, and yet many boards get in trouble when the black turns to  red. If you make $5,000 a month, and the combined mortgage and maintenance fees  on your condo are $5,001, that deficit is eventually going to become  problematic. Ultimately, you have but two options: you can A) make more money,  or B) move. Co-ops work the same way, but instead of a salary, the lion’s share of their revenue comes from the people who live in the building, through  either maintenance charges or assessments. These must—must—be high enough to pay for the costs of operating the building.  

 “One of the most common mistakes buildings make is maintaining the monthly  charges or common charges at a level that's not sufficient to cover operating  expenses,” says Abe Kleiman, a partner with the New York-based accounting firm Kleiman & Weinshank, LLP. “Board members need to realize that they need to cover day-to-day operating  expenses with revenue.”  

 Again, this is not rocket science. The math of it is easy to understand. It’s the politics that make it difficult. Having the requisite collateral of a  cooperative complex, boards actually have an option C: they can take out loans.  

 “Down the road, there's going to be a crisis when you need to replace that roof.  Are we going to do a special assessment? Are we going to borrow money?' If you  borrow money you're going to have to pay it back, and maintenance fees will  have to go up,” says Jules Frankel, CPA, a shareholder at the certified public accounting and  consulting firm of Wilkin & Guttenplan, P.C., with offices in New York City and East Brunswick, New Jersey.  

 Borrowing money for a large expense that comes up four times a century is one  thing. But, borrowing to pay the electric bill and the super’s salary? That will catch up with you.  

 Ideally, the maintenance fees collected from residents are enough to cover  operating costs, plus add a bit each month to the cash reserves. “The biggest problem is not setting budgets at a realistic level, which means  setting maintanence fees at a reasonable level--not setting aside money for  replacment funding means not having the money for projects when they come  about,» says Frankel. Cash reserves are vital, in the event of emergency, and also to  avoid having to resort to assessments for every little problem that crops up.  

 With stricter controls being mandated by Fannie Mae and Freddie Mac since the  mortgage crisis in the late 2000s, banks are keeping a watchful eye on the  financial health of co-ops and condos in the event they have to sell the  mortgages to the government. Lenders used to concern themselves solely with the  creditworthiness of the borrower. Now, they’re looking at the entire financial condition as a whole, especially the money  held in both operating and capital reserve.  

 Shareholders and unit owners may complain vociferously about a maintenance  increase, especially in the current economic climate. But over time, an  increase now will save the building—and those same unhappy shareholders and unit owners—money, because loan interest will be minimized.  

 Watch the Store

 According to the financial professionals, another big mistake board members make  is not paying close enough attention to the inner workings of their building’s finances. Maybe they don’t have the expertise to go through a budget line-by-line, or maybe terms like “receivables” go over their heads. Maybe money matters just don’t interest them. No matter. A board member should be armed with some basic information so at the very least,  they know when something seems fishy and can ask intelligent questions about  it.  

 “They want to be popular, they want to keep the fees the same. But if you think  about it, gas prices go up, food prices go up. It's not reasonable to think  that the cost of living in a condo is not going to go up in 20 years,” says Frankel. When board members are more concerned with power and influence than credit and  debit, the entire building community suffers.  

 Board members should ask themselves a few key questions to make sure the  finances are humming along: are the people paying their maintenance fees on  time? Are a lot of people in arrears? This is especially relevant now, with the  effects of the recession still very much visible. There will always be a  certain percentage of units in arrears, just like unemployment will never be at  zero, or literacy at 100 percent. But if a big swath of units are behind in  paying their fees, that can herald a disaster—especially in a smaller co-op where the shortfall can’t be spread out among hundreds of owners.  

 Just like in a regular house, a stack of unpaid bills is never a promising sign.  And just as the heads of a household should be in the loop about that  household's accounts payable, all shareholders—not just board members—should look at the annual minutes. Can this be dull? Sure. But if everyone leafs through it, problems will be spotted.  

 Another issue: the revenue items in the budget. During the real estate boom,  boards factored revenue from flip tax collection into their budgets. As the  market cooled off that revenue stream slowed to a trickle or dried up entirely. In the face of the recession, relying on a flip tax is magical  thinking.  

 A trusted property manager can be invaluable for making sure the books are well  maintained. “The property manager should be supplying, usually on a monthly a basis, a  year-to-date actual vs. budget report, a balance sheet, and an aged receivable  and payable listing, that boards should go over in their meeting to see where  the association is at,” says Frankel. And making that kind of information isn't just polite—it's the rule.  

 In addition to the basic financial statements and notes mentioned above,  Cesarano says that the American Institute of Certified Public Accountants  (AICPA) requires co-ops and condos to disclose supplemental information about  the estimated remaining lives and replacement costs of the property and the  funding of future major repairs and replacements.  

 This analysis is crucial for boards in meeting their fiduciary duty and  preserving their building. It is also their responsibility to decide how to  fund the cost of future projects. Inadequate funding can negatively impact the  ability of owners to sell or refinance their units, because of the concerns of  prospective buyers, or because of the difficulty of obtaining mortgages—especially now that the FHA has significantly tightened its purse strings.  Finally, Cesarano adds that having a clear picture of its financial landscape  allows boards to budget wisely and avoid having to levy burdensome assessments  on residents to pay for large projects.  

 Transparency and openness—within reason, of course—fosters a climate where accounting errors are caught early on and corrected,  helping to prevent the kind of accounting sleight-of-hand that can lead to the  third common mistake.  

 Keep Track of Valuables

 The best way to prevent fraud is to eliminate temptation. After all, the kid won’t take cookies from the cookie jar if there are three other adults in the room  with an eye on the counter, and one of those adults has an advanced degree in  watching cookies. Most buildings hire accountants and lawyers, but if yours  doesn’t, “They should look at the type of resources a particular firm could offer them in  terms of industry knowledge,” says Frankel.  

 Accountants also need to have the proper communication skills to make sure they  are being helpful to their clients. “They need to understand that for most associations, boards are made up of  volunteers, many of whom have limited financial backgrounds, and while an  accountant is usually hired to perform an audit for the association, the  accoutant also needs to be an educator for the association to help them  understand what the financial statements mean,” says Frankel.  

 Which goes back to the importance of disclosure, checks and balances, and  transparency. Each co-op or condo should have its own individual building bank  account via the managing agent; all the funds from a manager's client buildings  should never be dumped (co-mingled) into a single, central, (or even an  off-shore or overseas) account.  

 The take-away message is that while relatively rare, fraud does happen. Some  boards might not think it does because they don't receive that much media  attention. That's why it's important to separate duties, and make sure you're  asking all the right questions to property managers and accountants.  

 This might sound intimidating, but really, finances are all about doing some  homework to familiarize yourself with your building's financial profile,  planning ahead with the help of experienced, competent professionals, and  keeping things clear and well-supervised whenever money is concerned. With a  conscientious, committed board and a group of competent professionals, managing  your building's finances can be as easy as 1-2-3.                          

 Greg Olear is a freelance writer and a frequent contributor to The Cooperator.  Editorial Assistant Tom Lisi contributed to this article.

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