Tutorial – Funding Strategy
Establishing a Funding Plan
You now have all the required information to complete a Reserve Study. Next, you must select a funding strategy. This decision is very important and has serious financial implications for your association. Various funding methodologies have evolved to determine this allocation, however, the component, straight-line and cash flow methods dominate most reserve study reports:
- The component method determines reserve allocation by dividing cost by useful life for each component and then totaling. This method provides the greatest detail in the reserve study and is preferred by our company.
- The straight-line method is similar, 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 provide for “independent funding” of each component.
- The cash flow method determines reserve allocation by projecting reserve allocations and disbursements over a timeframe of thirty years and testing different allocations until a minimum allocation is found that maintains a Percent Funded or Net Reserve Balance amount above a specified funding goal (perhaps a Net Reserve Balance of zero dollars for Baseline Funding). This method provides for “collective funding” of all components.
The preferred funding strategy we use is the component method. This has the greatest level of detail In general, it examines and projects the Reserving needs (contributions and expenditures) over many years, funding all components, in order to determine a stable annual contribution.
In order to establish your funding plan, you need to determine:
- What is your current reserve balance?
- Do you currently invest the money in your Reserve Fund? If so, what is the investment rate?
- What tax rate applies to the interest or dividends earned on the invested Reserve Funds?
- What is the current area inflation rate? This is important because in a cash flow analysis, you examine the contributions and expenditures over five or more years.
Once you have determined these parameters, you are ready to put together your cash flow analysis.
Investing in a comprehensive reserve study and following a carefully charted funding plan will reap huge dividends in the coming years. Let Pacific Crest Reserves come in and meet with your association to discuss a reserve study.