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How To Protect HOA Reserve Funds And Operating Funds

Fraud and embezzlement cases in homeowners associations are on the rise. You’ve likely heard of someone — be it an administrator, treasurer, or president — trying to steal money from their community. The truth is, these scams can be quite simple. All it takes is to write one’s name on the check without the association ever knowing about it. So, if you want to protect HOA reserve funds and operating funds, here’s what you need to know.

 

Protect HOA Reserve Funds and Operating Funds: What Are They?

Before discussing ways to protect your association’s finances, it’s important to know the difference between operating funds vs reserve funds. You should also know why these accounts are important to your association.

Most associations have two accounts: reserve funds and operating funds. A reserve fund functions as the association’s savings account. It is used to fund future projects, large-scale repairs, and unexpected expenses. Construction of a new swimming pool, a major roof repair, and hurricane damage are all projects that will be covered by the HOA’s reserve fund.

Since these are quite expensive projects, it would be difficult for an association to pay them off in lump sum. So, instead, the HOA will allocate money in their reserve account for a period of time — or until the project needs to be paid off.

Meanwhile, an operating fund is used to pay for the day-to-day expenses of the community. This would include maintenance services, security, landscaping, utilities, management fees, taxes, and insurance. Ideally, HOAs should have about 1 to 3 months’ worth of operating funds in their account.

Why Do You Need to Protect HOA Reserve Funds and Operating Funds?

question | hoa reservesBoth reserve funds and operating funds are important to an association. Without the latter, the community would not be able to operate properly on a daily basis.

And without a sufficient reserve fund, the community won’t be able to pursue projects that lead to scalability and growth.

Board members, especially the treasurer, are in charge of managing HOA reserves and operating funds. However, because these members are essentially volunteers, they do not always have the expertise to handle financial tasks such as accounting, bookkeeping, invoices, and collections. Most communities would then employ an HOA management company to handle essential services.

Whether you’re a self-managed association or a community with professional HOA management, there is always a risk of fraud, embezzlement, or misappropriation of funds. If you want to protect the financial health of your community, you need to safeguard your reserve funds and operating funds.

How to Protect HOA Reserve Funds and Operating Funds

Theft, fraud, or embezzlement can create major damage to your association’s finances. Even if the HOA has adequate insurance coverage, there is no guarantee that you will be able to recover the money completely. In some cases, it may even take years to recover stolen HOA funds.

Nevertheless, the community needs to keep running. It will be up to the board to find ways to cover operational expenses and replenish reserves. This can be a major headache. As a precaution, it’s important to establish safeguards that will deter or eliminate fraudulent activity in your community.

Here are ways to protect HOA reserve funds and operating funds.

1. Monitor HOA Finances and Accounts Regularly

Just because you have an HOA management company doesn’t mean that the board doesn’t have to monitor finances anymore. In fact, it is part of a board member’s fiduciary duty to oversee HOA finances regularly. With any kind of financial task, it’s better to have at least two separate parties as a check and balance. This means that one individual will never have complete responsibility for a financial task.

Board members should check bank statements, bank reconciliations, operating cash levels, HOA assessments, vendor payments, etc. Even without a financial background, it can be easy to monitor the money coming in and out of your accounts and making sure that they are accurately reflected in the bank statements.

2. Ask for Monthly Financial Reports

The treasurer or HOA management company should be able to provide all board members with copies of financial reports within the next month. It will be easier to identify fraudulent activity when you review financial reports on a monthly basis. Make sure that the reports include revenues, expenditures, and balance sheets.

As an added layer of protection, the board can also ask for financial reports randomly. Since employees or personnel know that random reviews are possible, it might deter them from doing anything criminal or illegal with the association’s funds.

3. Test HOA Invoices

The HOA board can also hold a test of invoices periodically. This will help you see if vendors are being paid more than what was agreed upon or whether there are bogus charges. An easy scam would be to create invoices for work that was never completed, then write a check for that amount.

Unless you are reviewing canceled checks or verifying invoices, it’s quite easy for the thief to get away with it. Each time you have a supplier or contractor going over budget, this is likely to be the cause. So, in order to protect HOA reserve funds and operating funds, ask contractors to review their invoices with you.

4. Establish a Lockbox System for HOA Fees

If you do not have an online portal for HOA fees, you are likely dealing with a large amount of cash and numerous checks each month. Having cash and checks lying unattended in your office — until they are deposited to the bank — creates unnecessary risk for your HOA.

To safeguard the HOA’s money, you can set up a lockbox system with your bank. Homeowners can directly mail their checks to the bank. The bank will then deposit the checks into the HOA’s account. Since there are fewer people handling these checks, there’s also a lower chance for fraudulent activity.

5. Restrict Access to Bank Accounts

restricted | hoa reservesHOA boards authorize management or employees to conduct financial tasks, such as withdrawing money from the bank, for more seamless operations.

However, the board may want to put restrictions when it comes to making major purchases, withdrawing large amounts, or transferring money to other accounts.

Anyone accessing the bank accounts should first receive authorization from the board.

You should also make sure that your reserve funds cannot be easily withdrawn or transferred. Talk to the institution holding your funds and ask them how to set up internal controls to prevent fraudulent activity.

6. Have Adequate Insurance Coverage

Make sure that your association’s insurance covers any money that may be lost to theft. Too often, HOAs think that their management’s fidelity insurance protects them — it doesn’t. It only protects the management company if an employee steals from them. So, whether it’s fidelity and crime insurance or directors & officers insurance, make sure you are covered for any loss — no matter who is lining their pockets.

7. Perform an Annual Audit

Get an audit — not an opinion, not a compilation, but a real, comprehensive audit. An audit from a third-party CPA is one of the best ways to ensure that your finances are all legitimate. The CPA can easily unearth evidence of fraud and embezzlement.

Yes, an audit is more expensive, but considering the huge increase in financial crimes in HOAS, this is not the time to be stingy. Remember, every person trusted the people who were scamming the association’s funds. The fact that a treasurer is a good person does not mean that they are not having personal financial problems.

Protect HOA Reserve Funds and Operating Funds to Keep Your Community Safe

 If the board is unable to protect HOA reserve funds and operating funds, then they would have failed their fiduciary duty to the association. Failure to prevent theft, fraud, or embezzlement also brings on financial hardships to your community.

That’s why it’s important to have necessary protections in place — and to make sure that they are actually being followed. HOA board members should always fulfill their responsibilities and remain vigilant for any fraudulent activity within the association.

 

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