What are Reserve Study Funding Methods and Goals?
Funding Methods are ways to determine how much the Reserve Contribution Rate and what the corresponding Reserve Fund Balance should be. There are two methods of calculating the results of the financial analysis. The first is the Straight Line or Component Funding Method & the second is the Cash Flow Method. The Straight Line Method is a simple calculation that calculates a reserve contributions based on each individual component.
The Cash Flow method uses the cash flow of the Reserve Fund to calculate results and is capable of determining reserve contributions needed to meet various funding goals. There are four most common funding goals; the Baseline Goal, Threshold Goals, and Full Funding Goal and the Statutory Goals. The funding Goal selected depends on the risk tolerance and best interests of the community.
The Baseline Goal – The goal of this method is to keep the Reserve Fund from dropping below a zero balance. This is the most risky goal because if an expense arrives early or unexpected there is a significant chance of needing a Special Assessment. This goal contributes the least amount of money to the Reserve Fund.
The Threshold Goal – Different goals or Thresholds may be set to determine the Reserve Contribution Rate and corresponding Reserve Fund Balance. Threshold Funding sets the Reserve Contributions to whatever level is needed to obtain the specified goal. Threshold Funding is common when an Association does not want to be Fully Funded or Baseline Funded. Common goals to achieve and maintain are 70 Percent Funded or always maintain a cash balance of the prior year’s Reserve Contribution or setting a minimum cash balance to never fall below “x” dollars, such as $50,000. Whatever the goal determined is the Threshold the Reserve Fund is planned to meet or maintain.
The Fully Funded Goal is the most conservative, fair and equitable funding goal. This sets the Reserve Contribution Rate to achieve a Fully Funded Balance. Fully Funded is achieved when the Reserve Fund Balance is the same as the Fully Funded Balance also known as 100% Funded.
The Statutory Funding Goal is used when State or local regulations govern minimum Reserve Fund Balances.
The various goals and options allow the Association should choose a contribution rate that will meet their Funding Goal.