Demystifying HOA Financial Statements

Homeowner Associations (HOAs) are tasked with managing the finances of their communities effectively. As a nonprofit corporation, most states require laws that require the corporation, in this case, the HOA, is required to keep financial records that are subject to the inspection of the members.

Unfortunately, many board members that volunteer for the position do not have experience reading financial statements. Because one of the essential aspects of the board’s responsibility is maintaining accurate financial records and producing comprehensible financial statements, it’s important to understand these concepts. Understanding HOA financial statements is crucial for board members, residents, and anyone involved in the management of the community. Luckily, the basics aren’t as difficult as one might think.

In this guide, we'll delve into the key components of HOA financial statements and shed light on some essential concepts that will help your board.

 

Balance Sheet:

The balance sheet provides a snapshot of the HOA's financial position at a specific point in time. When you read a balance sheet, you are looking at the current balances of the listed accounts as of a particular date.

The balance sheet consists of three main components:

- **Assets:** Assets represent what the association owns or is owed. Common assets include bank accounts, petty cash, accounts receivable, cash reserves, and equipment.

 

- **Liabilities:** Liabilities are the obligations or debts that the association owes to others. This may include accounts payable, loans, accrued expenses, or prepaid assessments.

 

- **Equity:** Equity, also known as the net worth or owner's equity, represents the difference between assets and liabilities. It reflects the association's financial health and its ability to meet long-term obligations. Equity is calculated using a simple formulate:

Equity = Assets - Liabilities

 

**2. Income Statement:**

 

If the balance sheet is a snapshot of the association’s financial health at a particular point in time, the income statement shows a summary of the income and expenses over a period of time. For example, if the balance sheet is for the last date of the month, then the income statement will show the income and expenses for the corresponding month.

The income statement, also known as a profit and loss statement, typically includes:

 

- **Revenues:** Revenues consist of income generated by the association, such as assessments, fines, late fees, interest income, and other miscellaneous income sources.

 

- **Expenses:** Expenses encompass the costs incurred by the association in running its operations, including maintenance, utilities, insurance, administrative costs, landscaping, management costs, legal and professional fees, and any other expenditures.

 

The income statement helps assess the association's financial performance and whether it is operating within its budget.

It is also common for the income statement to show the current period as well as year-to-date (YTD) numbers.

 

**3. Accounts Receivable:**

 

Accounts receivable refers to amounts owed to the HOA by homeowners for assessments, fees, or other charges. The total amount shown on the AR report should match “Accounts Receivable” on the Balance Sheet.

It's essential for the association to track accounts receivable carefully and follow up on any overdue payments. Delinquent accounts can impact the association's cash flow and ability to fund essential services and maintenance. When A/R becomes excessive, the association will have difficulty meeting its budget and may have to raise assessments for the entire association in order to mete its obligations.

 

**4. Accounts Payable:**

 

Accounts payable represent the amounts owed by the HOA to vendors, suppliers, contractors, or service providers for goods or services received but not yet paid for. Managing accounts payable effectively is crucial to maintaining positive relationships with vendors and avoiding late payment penalties.

It is common to have an A/P of $0 as many associations pay their expenses the month they are incurred. However, it may be more common when associations use accrual accounting to record the expenses as soon as they are incurred, but not pay them until a later date. For example, if an HOA pays its expense on a Net 30 basis (30 days), and receives a bill in late October that isn’t paid, the balance sheet for the month ending in October will show an Accounts Payable amount for the unpaid bill.

 

**Accrual vs. Cash Accounting:**

There are two many types of accounting practices – Accrual and Cash. Cash accounting is what most people use for their personal finances and is used by many small business owners.

Accrual accounting is more common for associations and is generally recommended for associations because it paints a better overall picture of the association's financial health. More on that in a second...

With accrual accounting, revenues and expenses are recorded when they are earned or incurred, regardless of when cash actually changes hands. In contrast, cash accounting records transactions only when cash is received or paid out. Both methods have their pros and cons:

 

- **Accrual Accounting:** Provides a more accurate picture of the association's financial performance by matching revenues with the expenses they generate. However, it may require more complex record-keeping and can be challenging for smaller associations without a dedicated HOA bookkeeper or accountant.

 

- **Cash Accounting:** Simpler and easier to understand, as it tracks cash flow directly. However, it may not reflect the association's true financial position accurately, especially if there are significant timing differences between when revenues are earned and when cash is received. Cash accounting may be better for smaller associations that have a limited number of accounting transactions each month.

 

**Best Practices for HOAs:**

 

While both accrual and cash accounting methods have their merits, accrual accounting is generally considered more suitable for larger HOAs with complex financial transactions. Accrual accounting provides a clearer picture of the association's financial health and performance over time, facilitating better decision-making and long-term planning.

 

However, smaller HOAs with simpler financial structures may find cash accounting sufficient for their needs, as it requires less administrative overhead.

 

In conclusion, understanding HOA financial statements is essential for effective governance and financial management. By familiarizing themselves with the balance sheet, income statement, accounts receivable, and accounts payable, board members and community stakeholders can make informed decisions that contribute to the long-term sustainability and prosperity of the association. Additionally, selecting the appropriate accounting method based on the association's size and complexity is critical for maintaining accurate financial records and ensuring compliance with regulatory requirements.

If you have questions or need assistance with your association, contact us today.

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