2005 January
The warning signs of financial distress
By Sam Tomasetti, CPA

From an Accountant’s Perspective

Our firm has been working with condominium associations for about twenty-five years now, and we have serviced well over one hundred entities. Over the years, we have seen a number of situations where condominium associations were heading towards or were firmly entrenched in financial distress and most shared certain basic characteristics.

Case #1 In one situation the numbers looked liked this:

1. Lots of cash in the operating and replacement reserve accounts.
2. No monthly condominium common charges outstanding.
3. Lots of common charges paid in advance by unit owners.
4. Bills payable to venders in an amount in excess of the cash in the operating and reserve funds combined.
5. No budget.
6. No replacement plan budget.
7. Self managed.

Although for many of us having lots of cash on hand seems like everything is fine, a closer look suggested there was more to the story.
 
Having lots of cash doesn’t mean things are going well especially if the bills you have to pay are greater than your cash and you have collected all the funds due to you now as well as a significant portion of the funds due to you in the future.  This association was basically using the funds from today and some from tomorrow to try to keep up with the bills due today. 

Secondly, we saw an association that had no financial plan and no yardstick to measure how it was doing in accomplishing its plan.  This happens when there are no budgets.

Looking deeper into not having budgets, we determined the association had no formal bid and contract process with its contractors.  As a result, the work was not clearly defined. The best professional for the job was not evident and quality and cost expectations were vague at best.

In this situation what we generally saw was an association that was living in the present in an effort to keep monthly charges down.  We saw a group of well-intentioned individuals who were afraid to seek the help of people who could explain to them the significance of planning.

Case # 2 In another situation here is what the records showed:

1. Small cash balances.
2. There were uncollected common charges, and a large percentage of them were outstanding past thirty days.
3. No common charges were received in advance.
4. Lots of bills were owed to vendors and many were more than thirty days old.
5. Actual expenditures were well in excess of budgets for several years.
6. There was no replacement reserve plan.
7. Their bank loan was in default.
8. The board of directors was uninvolved and contentious.

Because the bank loan was in default, this situation is probably easier to see as an association heading toward financial distress than some others.  When the bills are mounting and payments are being missed and no one wants to be involved, the situation is certainly dire.

When we looked at the circumstances behind the numbers, we became aware that another reason the association had gotten into an unfavorable situation was the board’s reluctance to commit time and resolve any difficulties in working relationships.

Case # 3 Finally we see this situation quite a lot:

1. Cash, common charges due or collected in advance and bills owed to venders do not appear as trouble spots.
2. There are no significant annual operating budget variances.
3. There is a long list of deferred maintenance items.
4. There is no replacement study or plan.
5. The operating fund used to pay everyday bills borrows from the replacement fund and never repays the loans.
6. The community is hit by external forces such as a financially troubled economy with significant job loss among the unit owners or a pending lawsuit.

If at the time we simply looked at the numbers that are readily available from most accounting systems, this situation would appear to be fine. However, a closer look revealed some significant problems. 

The replacement reserve was not fine.  It had loaned a large portion of its funds to pay the everyday bills of running the association with no prospect of being repaid.  What would happen if a major repair or replacement was needed?  The association did not have a realistic replacement fund balance.  The funds simply were not there.

A long list of deferred maintenance items was also a warning sign for trouble to come.  In this case, the budgets were on target, but they were missing the maintenance items that needed to be taken care of today so that the ultimate cost would not be significantly greater in the future.  This association was keeping its fees to a bare minimum hoping things would get better and not realizing they needed a plan if things did not get better.

Sometimes there is important financial information that needs to go along with the basics to tell the rest of the story.  When we attempted to assign costs and a timeline to the list of deferred maintenance items or replacement items, we could see that the association did not have the ability to raise its fees and put away the funds necessary to handle these items (especially when the general economic times were considered).

Our experience in working with condominium associations has taught us these key points regarding when financial troubles are coming:

1. No budget for operations and replacements. 

2. No rainy day funds.

3. Annual operating actual expenditures that show a trend of being consistently greater than budget expenditures. 

4. No analysis of maintenance items and their annual costs.

5. No reserve study and no plan on how to deal with these projects when they will arise.

6. A board of directors that is ineffective in handling the affairs of the association either directly or through the use of outside professionals.

To avoid financial troubles, the bottom line for condominium associations is is that it is essential to plan how much money is needed, plan when its needed, and plan how you to obtain the necessary funds.  These rules are not always easy to follow but to ignore them invites troubles that are far worse.

Sam Tomasetti, CPA is a principle in the accounting firm of Tomasetti, Kulas & Co., P.C.  Sam served on the CAI-CT Board of Directors as its Treasurer from 1999-2003.  He is currently Co-chairperson of the Publications Committee.