The key to proper financial management of a co-op begins with the presence of a strategic plan. This plan should include, at a minimum, a projection of necessary capital improvements; and a forecast of revenue and expenses over a chosen number of years. The number of years, included in the plan, should be chosen based upon such guidelines as to the building age, its physical condition as well as governmental requirements. Just as important is to include “quality of life” improvements for shareholders within the plan, such as an exercise facility and meeting rooms.

One essential source of information for use in the preparation of a strategic plan is a periodic reserve study. The reserve study will identify necessary physical changes to the building and suggested dates by which to implement those changes, based on the projected remaining life of capital items like boilers, elevators, piping, etc., and selected long-term expenses such as exterior repair.

Two additional sources of information necessary for the preparation of a capital budget are governmental and self-imposed life-safety and security requirements.

If there's one culprit that causes co-op boards to get behind the curve in managing finances, it's deferring essential capital item replacement. Such deferments result in more expensive scheduled maintenance and excessive cost of break-down maintenance. One sign of a board’s hesitance to keep their building in good condition is the amount of debt it carries, often resulting from failure to build reserves through appropriate monthly assessments.

Budgetary Issues

It should be expected that a co-op's management company will provide the board with a budget, including a chart of accounts that supports all aspects of income and expenses. Parts of the budget that are time-consuming but relatively easy to project are:

• Income based on projected assessments.

• Expenses based on experience, e.g. supplies and contracted straight-time labor.

• Expenses based on contractual obligations, e.g. elevator maintenance.

Almost impossible to budget for are large payments to contractors for such items such as unexpected fire escape

Exacerbating the hassle of the entire budgeting process is when the budgeting and accounting systems are based on a cash system rather than an accrual system. Simply stated, income and expenses are incurred in a cash system when the cash is received or paid-out.

By contrast, in an accrual system income is recorded when an invoice is issued, e.g. to a shareholder; and an expense is recorded when an invoice is received from a vendor. In addition, liabilities can also be accrued throughout the year based on job progress. This latter step is vital to budgeting in order to reduce annoying short-term variances between budgeted and actual expenses.

Key Performance Indicators (KPIs)

Easily identified and understood, KPIs are tools that utilize financial information drawn from financial reports. KPIs measure progress against goals. Two characteristics that set them apart from budgets are that they involve more than financial information and that they can be used to examine trends.

Generally, financial reports are prepared monthly and compare actual income and expenses to budgeted amounts for the same period and for year to date. Variances are reported, sometimes on different reports, reflecting percentage of difference, or differences year to year.

Useable—if rudimentary—indicators of variances between actual income/expenses and budgeted items are often reported as overages or shortages amounting to $1,000 or $2,000 over or under budget or a percentage difference exceeding some established percent.

Co-ops should establish goals that go well beyond financial matters. Some valuable non-financial goals may be defined as follows:

• Vendor turnover (measures substance and effectiveness of vendor relationships)

• Employee turnover (measures ability of property management’s human resources capabilities)

• Number of apartment vacancies (measures the attractiveness of the building and its shareholders)

• Sale price per square foot of apartment sales (original)

• Sale price per square foot of apartment sales (rehabbed)

However, the problem with variance reports is that they don’t tell the reader how actual versus goals is trending, nor do they reflect the standard deviation of the actual amounts.

Trendequals a tendency to take a direction (we look for movement away from a goal).

Standard Deviation equals a measure of dispersion in a frequency distribution, equal to the square root of the mean of the squares of the deviations from the arithmetic mean of the distribution. (Understanding the expected “standard deviation” of future amounts within a distribution will tell you when not to get overly concerned by expected differences from the mean).

Therefore, your board should establish goals to be achieved over a selected period of time, compare the actual to the related goals, periodically, and plot the trend to determine if course corrections are required. n

James B. Peterson is president of the board of directors of a Chicago Lake Shore Drive cooperative.