Managing Donor-Restricted Funds in Nonprofit Organizations

Nonprofits often receive funding that comes with specific restrictions, which can make funds more complex to manage and track. A donor might want funds used for a specific program, or a foundation might require spending within a certain timeframe. None of that is unusual, but it does mean there’s more to manage behind the scenes, especially as a nonprofit organization grows. Understanding restricted funds, along with reporting and compliance responsibilities, is an important part of that picture. To help clients, prospects, and others, Klatzkin has summarized the key details below.

What Are Restricted Funds?

Nonprofits generally classify contributions as either with donor restrictions or without donor restrictions.

With Donor Restrictions — Restricted funds are contributions that come with limits on how or when the money can be used. For example, if a donor contributes $50,000 to support a summer day camp program, the funds may be used for camp supplies, activities, and counselor salaries but not for unrelated programs. Or a private foundation may provide funding for two $2,000 scholarships for students majoring in biology and pursuing graduate-level study. These restrictions are established upfront at the time of the gift, and they are legally binding, unless express permission is granted by the donor to change the terms.

Without Donor Restrictions — Unrestricted funds do not come with limits and may be used for any part of the budget. This kind of donation is common during fundraising and annual giving campaigns. For example, if an individual donates $250 during an open-ended holiday donation drive, it may be used for any purpose within the nonprofit, including programs, salaries, utilities, or other operating expenses. In other words, unrestricted funds can generally be used as needed and at the discretion of the nonprofit.

When a nonprofit receives restricted funds, it needs to be prepared for additional tracking and management requirements, especially in the accounting function. Moreover, the donor may place a specific type of restriction on the funds, and oftentimes, donors include more than one type of restriction. This all needs to be recorded and managed in accordance with the nonprofit’s governing policies, state law, and applicable accounting standards. Of course, compliance is the most visible component, but donor trust is also at stake.

Common Types of Restrictions

• Purpose restrictions say how funds can be used. A donor may provide funding to be used only for a specific program or project, and the nonprofit is responsible for using those funds only for that purpose.
• Time restrictions say when funds can be used. A contribution may be received in December of one year but not available to spend until the next year. Some gifts include both purpose and time restrictions, which means both types of restrictions need to be tracked separately.
• Endowments are slightly different because they are longer-term donation vehicles. Typically, the principal is invested and left untouched. Then, investment earnings are used to support the nonprofit’s mission. Some endowments also include restrictions on how those earnings can be used. However, each endowment sets its own terms, which should be clearly documented. Spending needs to be managed and tracked separately from all other funds.
• Private grants are usually awarded for specific projects or programs, with or without a deadline. Again, everything must be tracked separately. Public grants are tracked in a similar way, but they often have additional compliance requirements, including Uniform Guidance.

Accounting and Reporting Considerations

Nonprofits are required to track how funds are spent throughout the year; however, restricted funds have a more detailed accounting process than unrestricted funds. Because contributions are recorded when received, nonprofits need systems and specialized software that can help record spending activity on a more granular level. This typically starts with separating restricted and unrestricted activity within the chart of accounts.

Many organizations use fund codes, grant codes, or classes to support this process. Even if all funds are held in a single bank account, the accounting records should clearly show what is restricted and exactly how those funds have been used.

Internal financial statements should show net assets with and without donor restrictions. This helps prepare the nonprofit for an audit, and it helps leaders see both total resources and available resources. Without this information, the nonprofit may overcommit with restricted funds that have been earmarked for specific purposes or for certain times. Or they may end up without enough cash flow for monthly operational costs like rent or utilities.

Best Practices for Managing Restricted Funds

• Document restrictions when gifts are received. Keep copies of gift agreements, grant awards, and any donor communications so there is a record of how funds are designated within the organization.
• Track restricted funds separately. Set up the accounting system to distinguish between restricted and unrestricted funds, and use fund codes or classes. Staff members should be able to easily see what money is available and what money is committed to a specific purpose or timeframe.
• Review and reconcile funds regularly. Compare restricted funds to program spending to make sure funds are being used as the donor intended. Reconcile monthly, if possible, and quarterly at a minimum.
• Train staff on donor restrictions. Program managers and others who approve spending should understand any restrictions that apply to the funds they oversee and interact with.
• Communicate with donors. If a program ends or funds can no longer be used as originally intended, discuss other options with the donor. Document any changes. It may also be helpful to show how unrestricted donations support other aspects of the nonprofit; this can encourage more unrestricted donations, giving nonprofits greater flexibility.
• Consider outsourced accounting support. A specialized team can provide additional capacity and the necessary technology to help with reporting and compliance.

Contact Us

Managing restricted funds can be one of the more challenging parts of nonprofit leadership. It requires clear processes and consistent oversight. Nonprofits are encouraged to work with an advisor to review and manage funds throughout the year. If you have questions about the information outlined above or need assistance with another tax or accounting issue, Klatzkin can help. For additional information call 609-890-9189 or click here to contact us. We look forward to speaking with you soon.