Choosing Between Straight Line and Cash Flow Funding

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A body of new legislation affecting Florida associations was signed into law on 6/1/2010. Most significant in our opinion was the “Distressed Condominium Relief Act”. A number of issues relating to Reserves were adjusted, but they were primarily wording changes and cleanups. It still remains the board’s responsibility to “determine, maintain and waive” Reserve needs of the association appropriately, according to Florida Statues (see 720.303.6.b-g), and present those computations to the membership.

Those Reserve determinations can be computed using the “Straight Line” method or “Cash Flow” (pooled) funding method. This is more than an issue of personal preference, as Boardmembers and Managers need to be wise about deciding between the two. But from our point of view, the decision is clear and very simple.

There is a big difference between a task and a tool. As the old saying goes, “when all you have is a hammer, everything looks like a nail.” If all your focus is on the tool, you lose sight of your task. With respect to Reserves, focusing on the task means planning ahead for major repair or replacement expenses and making accurate disclosures to the members each year along the way.

Now onto the tools!

Straight Line Funding

The straight line funding method is a simple tool. Using this funding method, an Association is restricted from using funds being set aside for roofs if needed by another Reserve component. As an extreme, an Association with $200,000 in Reserves, but only with $35,000 allocated towards painting, would find itself unable to pay for a $50,000 painting project unless approved in advance by a majority vote of unit owners.

Cash Flow Funding

The cash flow funding method is another simple, but more flexible tool. Using this funding method, an Association assigns a “pool” of funds to be used for any and all Reserve projects. The classic weakness of this tool is when it is used in conjunction with a risky “Baseline” funding objective that only provide barely enough funds to keep the Reserves cash-positive. Thus, if the same association was facing a $50,000 painting project instead of the $35,000 project they had anticipated, they might likely find themselves in an underfunded situation.

The weaknesses of both funding methods are exposed when Reserve projects need to occur earlier, or are more expensive, than anticipated. Unfortunately, Reserve Studies are fundamentally based on making projections about future events that most likely will not occur exactly as planned. So what should a Boardmember or Manager do in this situation, where a tool’s greatest weakness is exposed to the industry’s greatest threat?

Cash Flow Funding with a Full Funding Objective

We think the decision is clear and very simple! Use the flexible “cash flow” method, in conjunction with a conservative “Full” funding objective. This means taking advantage of the strengths of the cash flow method (its ability to effectively and efficiently share Reserve funds among the different Reserve components of the association), and the strength of the “straight line” method (a more conservative funding objective). This eliminates the weaknesses of both funding methods, and sets the association up for success by using a tool in an effective manner.

With the introduction of National Reserve Study Standards in 1998, important parameters such as % Funded (a measurement of Reserve Fund strength) and Funding Objectives are now well defined. This gives Associations very clear choices, allowing them to make wise decisions that eliminate classic problems. You can pair the most flexible (cash flow) funding tool for the job with the most conservative (Full) funding objective for the Association. That’s a winning combination!