Financial analysis
Read the numbers inside your reserve study, and know what to ask when the assumptions behind them are missing.
A reserve study's financial analysis states where the association's reserve fund stands today and recommends how much to contribute going forward. Both parts rest on two stated assumptions: an interest rate and an inflation rate. If a study does not disclose those assumptions, the board cannot check the plan's math or judge whether it is realistic.
Two parts, not one
The financial analysis is one half of a reserve study. The other half, the physical analysis, inventories the association's components and estimates how much of their useful life is left. The financial analysis takes that physical data and turns it into dollars: the reserve fund's current position, and a recommended contribution schedule to keep it healthy.
A study that gives you a balance but no forward schedule, or a schedule with no stated assumptions behind it, has left out half of what a financial analysis is supposed to contain.
The two assumptions that drive the plan
Every funding plan is built on an assumed interest rate and an assumed inflation rate. They do not carry equal weight.
| Assumption | What it affects |
|---|---|
| Interest rate | Growth of dollars already sitting in the reserve account |
| Inflation rate | Future replacement cost of every component the association is responsible for |
"Inflation has a much greater impact on the funding plan" than the interest rate assumption does.
Source: What's Included in a Reserve Study? Key Elements Explained, Reserve Advisors
Interest only compounds money the association already has. Inflation raises the price tag on every future project, funded or not, which is why a small change in the inflation assumption moves the whole plan more than the same change in the interest assumption.
What to do if the assumptions aren't there
Current reserve disclosure practice calls for the study to state both rates, so the board can trace the recommended contribution back to the numbers behind it. If your study doesn't show them, ask the preparer for the rates used and the reasoning, before adopting the recommended contribution as your budget line.
How often your board is required to revisit the study itself varies by state and by your governing documents; see what your state's law requires before assuming an annual review is standard everywhere.
Check yourself
Answer before you read the explanation, recalling it is what makes it stick.
Your reserve study shows a healthy current balance but never states what interest or inflation rate it used for future costs. What should the board do?
A preparer raises the assumed interest rate and, separately, lowers the assumed inflation rate by the same amount. Which change moves the funding plan more?
A board reviews a document labeled financial analysis that lists the reserve fund's current balance but has no recommended contribution schedule. What should the board conclude?
Sources
- CAI Releases New Reserve Study Standards for Community Associations, Community Associations Institute
- What's Included in a Reserve Study? Key Elements Explained, Reserve Advisors
Reserves
Next, see how the physical side of the study feeds these numbers in Physical analysis.
Which interest and inflation rates a preparer should use, and how often your board must review or update them, vary by state law and by your association's governing documents.