The financial analysis is a funding study that utilizes the physical analysis to determine:
- reserve allocation
- percent funded (general strength indicator)
- cash flow analysis (projection or forecast)
The reserve allocation (or funding plan) is a significant part of the overall budget, and therefore, considered the most critical element of the funding study. The method utilized to determine this allocation is normally established by the reserve study firm (or by statutory requirements in some states). In states without statutory requirements, the association should always have the option to carefully consider and select the method themselves. Various methodologies have evolved to determine this allocation, however, the component and cash-flow methods dominate most reserve studies.
The component method determines reserve allocation by dividing current cost by useful life for each component, and then summing for a total. The straight-line method is similiar, and determines reserve allocation by dividing the difference between fully funded balance and reserve balance by the remaining life for each component and then totaling. Both methods allow for:
- independent funding of each component
- provide no flexibility to utilize various funding goals (the allocation is fixed)
- but are very easy-to-understand
The cash-flow method, on the other hand, determines reserve allocation by projecting reserve income and disbursements over a timeframe (twenty years minimum) and testing different allocations by trial and error until a minimum allocation is found that maintains a net reserve balance above an established funding goal (perhaps zero for baseline funding). This method allows for:
- collective funding for all components
- provides the flexibility to utilize various funding goals
- but is slightly more difficult-to-understand
A funding goal is normally established by the reserve study firm (or by statutory requirements in some states). In states without statutory requirements, the association should always have the option to carefully consider and select the funding goal themselves. Basic funding goal categories typically include:
- Baseline Funding- Maintaining a Reserve Balance above zero.
- Full Funding- Maintaining a Reserve Balance at or near Percent Funded of 100%.
- Statutory Funding- Maintaining a specified minimum Reserve Balance and/or minimum Percent Funded as required by local statutes.
- Threshold Funding- Establishing and maintaining a minimum Reserve Balance and/or minimum Percent Funded.
Percent Funded is of particular importance, for it provides a general indication of reserve strength. Strategic Reserves is the only Professional Reserve Study firm to interpret this strength indicator in terms of risk associated with the availability of reserves to fund future expenditures. These levels follow:
Level of Risk
|70% and above
|31% to 69%
|30% and below
The cash flow analysis is a projection (or forecast) of anticipated reserve income and disbursements over a timeframe of twenty years minimum (a National Reserve Study Standard). Association management needs to understand that- the probability for an accurate projection decreases as the timeframe increases and that successful plans must ensure that enough "cushion" is provided to fund the"estimated" reserve disbursements.
Factors considered in the cash flow analysis typically include:
- interest earned on reserve investments (adjusted for any taxes imposed)
- reserve allocation increases to compensate for inflation
- reserve component increases due to inflation
Strategic Reserves normally utilizes the cash flow method to determine reserve allocation with a threshold funding goal that is established by analysis of the association's current physical and financial condition. We are the only Professional Reserve Study Firm that has the flexibility to adapt and implement various funding methods and goals based on statutory requirements or individual association preferences. If you have a particular method and/or goal preference, just let us know and we'll honor your request.
Although the reserve funding level may fluctuate from year to year, our own experience in the preparation of numerous reserve studies has revealed that Percent Funded of at least seventy percent (70%) normally indicates that reserves are strong and can be expected to fund future reserve item expenditures with low-risk of financial instabilities. Association management should be made aware that certain levels of risk are inherent in any long-term reserve funding plan. The plan must therefore provide a strategy that minimizes risk, while maximizing success!