An HOA budget variance may seem like a non-issue, but board members would be wise to monitor even the smallest of variances. Sometimes, seemingly insignificant gaps can signal a larger problem in the budget. Understanding what a variance is, how to compute it, and how to interpret it is crucial to successful financial planning.
What is an HOA Budget Variance?
An HOA budget variance is the difference between actual and budgeted income or expenses for a community. Some variances are small and normal, but others can indicate a growing problem within the association’s finances.
In an HOA or condo community, it is the board’s job to plan the budget. To do this, board members estimate how much revenue they expect to earn and how much in expenses they expect to incur. When these projections differ from the actual numbers, a budget variance occurs.
For example, if the board anticipated incurring $1,000 in maintenance costs this month but actually paid $1,500, there is a $500 variance. The difference can stem from a number of causes, including higher vendor rates, more component breakdowns, or just outright mismanagement.
Is it Good to have a Budget Variance?
A budget variance in and of itself is not inherently good or bad. It simply shows the difference between what the association budgeted and what it actually earned or spent.
To understand whether a variance indicates a problem, board members must take a closer look at what caused it and whether it is projected to continue. A variance can help the board identify gaps or issues in its budgeting or spending.
Favorable vs Unfavorable Variance
Variances can come in many forms. A small variance may be completely normal, stemming from fluctuations in vendor rates, utility costs, or delinquencies. Emergencies can also raise expenses unexpectedly.
That said, there are two general types of variance: favorable and unfavorable.
A favorable variance means that the HOA performed better than expected. It often involves the association spending less or earning more than projected. Perhaps it cut down on non-essential expenses or collected more in unpaid dues.
Meanwhile, an unfavorable variance is the opposite. It means that the HOA performed worse than expected, spending more or earning less than projected. It could indicate a problem with collections, an increase in expenses, or an unrealistic budget to begin with. Of course, it could also just be normal fluctuations in the economy.
Still, despite its name, a favorable variance could also raise some red flags. For example, if the HOA consistently spends far less than budgeted on maintenance, it could result in damage or premature deterioration. The board should investigate whether there is deferred maintenance.
How do You Calculate HOA Budget Variance?
To determine the budget variance, the basic formula is as follows:
Budget Variance = Actual Amount − Budgeted Amount
For example, an HOA budgets $12,000 for landscaping but actually spends $13,500. The calculation would be $13,500 minus $12,000. The difference is $1,500, an unfavorable variance.
The board can also express this as a percentage. The formula for a percentage variance is as follows:
Variance % = (Actual − Budgeted) ÷ Budgeted × 100
Using the above example, this would come out as:
($13,500 − $12,000) ÷ $12,000 × 100 = 12.5%
The same calculation would apply to income.
How to Avoid an HOA Budget Variance
Small variances are inevitable, as it’s virtually impossible for the board to predict revenue and expenses down to the last cent. Still, there are some strategies and tips that will help avoid variances, particularly large ones.
1. Use Historical Financial Data
Boards should look at past financial statements as a starting point when planning the current budget. The association’s actual expenses from previous years will help determine how much it expects to spend this year.
2. Account for Inflation and Contract Increases
Vendor contracts, insurance premiums, utilities, landscaping, and maintenance costs can all increase without warning. While reviewing past data is useful, boards should also consider current economic trends and contract changes when determining the budget. It helps to get in touch with vendors and providers to get a ballpark.
3. Separate Predictable and Unpredictable Expenses
It is much easier to forecast routine expenses than unanticipated ones. To stay ahead of the curve, the board should maintain adequate reserves and a contingency fund for operating expenses. This will help prevent an unexpected repair from creating a major variance.
Keep in mind that a reserve fund is a requirement in several states, Maryland being one of them.
4. Review the Budget Throughout the Year
The budget isn’t a “set it and forget it” type of tool. Board members should regularly monitor the budget to identify gaps, discrepancies, and other problems. Waiting until the end of the year to discover overspending or large delinquencies will be too late.
5. Investigate Significant Variances
Consistent budget monitoring will allow the board to spot significant variances quickly. Once identified, these variances should prompt questions. For example, if repairs are 30% over budget, the board should determine why before deciding how to proceed.
6. Don’t Ignore Small Variances
Large variances should trigger warning bells, but that doesn’t mean small variances should be overlooked. Small variances usually don’t require immediate action, yet they still require regular monitoring.
Instead of flagging a single small variance, the board should look for patterns. If the same variance appears every month, it could accumulate and become significant by the end of the year. A hundred-dollar variance per month can quickly add up.
7. Update Forecasts When Circumstances Change
An annual budget is a projection, not a fixed plan. If insurance premiums suddenly increase or a major contract changes, the board should revise its forecasts for the rest of the year. This will allow the HOA to adjust its position.
8. Coordinate the Operating Budget With the Reserve Plan
Some boards make the mistake of using the operating budget to pay for reserve expenses, such as roof replacements or pool renovations. These capital projects are typically funded by the reserves. Using the operating budget can result in an unexpectedly large variance.
9. Incorporate Realistic Revenue Projections
A variance in expenses doesn’t always indicate a rise in costs or more unexpected repairs. It could stem from poor revenue. When there isn’t enough money to pay for expenses, the budget can seem lopsided.
To avoid this, the board should anticipate realistic revenue. This means factoring in delinquencies (both current and additional) as well as other collection issues. Most associations don’t collect 100% of their accounts receivable in one go.
The Smart Plan
An HOA budget variance is not always good or bad. Some variation is unavoidable, so eliminating every discrepancy is a fool’s game. Instead, the board should focus on identifying significant differences, their causes, and the solutions that will get the association back on track.
Keymont Community Management offers expert management services to associations in Virginia, Maryland, and Washington, DC. Call us today at 703.752.8300 or request a proposal to start your journey!
RELATED ARTICLES:
- Is Your HOA Going Broke? Here’s The Truth About HOA Bankruptcy
- HOA Reserve Funds: Does It Protect Your Community’s Future?
- Understanding HOA Fees: What Are Homeowners Paying For?
