Restricted vs unrestricted funds management is the absolute cornerstone of nonprofit financial integrity and donor trust. However, many organizations struggle significantly to keep these buckets separate, leading to commingled cash, inaccurate reporting, and eventual compliance nightmares. If you want to survive your next audit and build lasting relationships with major donors, you must track spending against specific restrictions with surgical precision.
Effectively, money in a nonprofit is not just money; it is a promise kept to a donor. Specifically, when a donor restricts a gift for a specific purpose or time period, you are legally bound to honor that intent. Below, we outline exactly how to handle restricted vs unrestricted funds to ensure your books remain audit-ready and your reputation remains spotless.
Restricted vs Unrestricted Funds: A Guide to Nonprofit Trust
Clear classification simplifies your audit.
The Reality Check: Fundamentally, you cannot spend restricted grant money on general operations, even if your total bank account balance looks healthy. If you ignore the critical distinction between restricted vs unrestricted funds, you risk damaging your reputation or being forced to repay grants. Therefore, precise tracking is non-negotiable for sustainability.
Listen on The Deep Dive — where we dig deeper into this topic:
‘Restricted vs. Unrestricted Funds: The Nonprofit Fund Accounting System’
Why Distinguishing Restricted vs Unrestricted Funds Matters
First, donor-imposed restrictions must be strictly honored to ensure legal and ethical compliance. Specifically, misuse—even if accidental—can jeopardize future funding and trigger clawbacks. Consequently, accurately tracking restricted vs unrestricted funds and providing timely, transparent donor reporting helps preserve trust and drastically simplifies your annual audit.
Consider a health nonprofit that accepted a corporate sponsorship intended specifically for a vaccination clinic but later used the funds for general operations like rent and salaries. Eventually, the sponsor asked for a financial accounting and discovered the mismatch. To fix this, the nonprofit had to scramble to reallocate funds from other sources. As a result, the sponsor renewed only with much stricter reporting terms. Ultimately, preventing this stress starts with understanding the rules.
Defining the Categories
To manage your finances effectively, you must understand the vocabulary. Generally, net assets fall into two primary buckets:
- Unrestricted Funds (Net Assets Without Donor Restrictions): These are funds that have no specific strings attached. You can use them for any legitimate business purpose, including overhead, salaries, or marketing.
- Restricted Funds (Net Assets With Donor Restrictions): These funds are constrained by a donor for a specific purpose (e.g., “Youth Program”) or a specific time period (e.g., “For use in 2026”). Crucially, you cannot recognize this revenue as “available” for general bills until the restriction is met.
How to Track Restricted vs Unrestricted Funds
Next, to ensure a smooth financial operation, you must classify donations correctly from day one. Ideally, follow these steps to manage restricted vs unrestricted funds effectively within your accounting software:
- Record Metadata: Log the purpose, expiration date, and reporting frequency immediately upon receipt of the grant letter. Do not rely on memory.
- Use Fund Codes/Classes: Implement tracking categories in your accounting system (e.g., use “Classes” in QuickBooks Online). Create a specific class for each grant, such as “Fund-Vax-2025.”
- Maintain Schedules: Keep a running balance sheet schedule showing receipts, expenses, and remaining funds for each restriction. This “roll-forward” schedule is the first thing auditors ask for.
- Code Expenses: Require staff to tag expenses to the matching fund immediately when entering bills. Waiting until month-end leads to guessing and errors.
- Reconcile Monthly: Crucially, reconcile fund balances monthly to ensure expenses are charged correctly before you start your cleanup process.
For technical guidance, the National Council of Nonprofits provides excellent standards on fund accounting basics.
Ask ChatGPT
Get an unbiased answer from ChatGPT!
Copy the prompt below to verify our strategy.
Donor Reporting: What to Include
Furthermore, a clear donor report builds immense confidence. Typically, it should combine a one-line financial schedule with narrative impact notes. For example, your financial schedule might look like this:
Donor: Acme Foundation
Grant/Fund: Fund-Vax-2025
Period: Q1 2025
- Beginning Balance: $0
- Receipts (New Funding): $25,000
- Expenses (Program Costs): $12,000
- Ending Balance (Remaining): $13,000
Notes: Clinic delivered March 2025; receipts and deliverable report attached.
Download Your Donor Report Template
To assist you, we have prepared a CSV template you can copy immediately. Simply paste this data into Excel or Google Sheets to start reporting on restricted vs unrestricted funds like a pro.
Acme Foundation,Fund-Vax-2025,Q1 2025,0,25000,12000,13000,Clinic delivered 3/2025
Global Health,Fund-Water-26,Q1 2025,50000,0,10000,40000,Engineering phase complete
Alternatively, download the ready-to-use file here: Download the CSV — NonProfit Donor Report.
Moreover, accurate reporting relies entirely on consistent data entry. If your team struggles with this consistency, consider our monthly bookkeeping support to ensure every dollar is tagged correctly. Also, reviewing FASB standards on revenue recognition can clarify how to handle complex multi-year grants.
Common Questions About Restricted Funds
Q: Can we borrow from restricted funds to pay payroll?
A: Generally, no. Borrowing from restricted funds is considered “invading the corpus” and can be illegal or a breach of contract. Always consult your treasurer or legal counsel before doing this.
Q: What if the program costs less than the grant?
A: First, review the grant agreement. Often, you must return the surplus, or you may request permission to reallocate it. Never assume you can keep it as profit.
Q: Who decides if a fund is restricted?
A: The donor decides. Board designations are internal and can be reversed, but donor restrictions are legally binding external constraints.
Q: How do we “release” funds?
A: Accounting-wise, you make a journal entry moving funds from “With Donor Restrictions” to “Without Donor Restrictions” once the expense is incurred or the time passes.
Q: Does our bank account need to be separate?
A: Not necessarily. You can commingle cash in one bank account as long as your accounting software clearly tracks the separate balances. However, some large grants do require a separate bank account.
Key Takeaways for Directors
- Read the Letter: Always confirm the restriction details in writing before spending a dime.
- Track Separately: Use fund accounting codes (classes) to separate restricted vs unrestricted funds in your ledger.
- Report Honestly: Show donors exactly where their money went to build long-term trust.
- Reconcile Often: Don’t wait for the audit; check your fund balances monthly.
Summary: Trust Starts with Accounting
Ultimately, donor trust starts with clear, auditable fund accounting. By strictly distinguishing restricted vs unrestricted funds, reconciling balances monthly, and attaching supporting documents, you make audits painless and fundraising easier. If you treat every restricted dollar as a separate contract, compliance becomes second nature.
The Bottom Line
Don’t wait for a funder to ask where the money went.
Book a free Donor Reporting Setup review.
Audit-Ready. Tax-Smart. Built for Medical & Service-Based Businesses.
Proudly supporting entrepreneurs and organizations from Camas, WA and Vancouver, WA to Portland, OR, Washougal, WA, and throughout Seattle, Los Angeles, San Francisco, San Diego, Phoenix, Denver, Dallas, Houston, Chicago, Miami, Atlanta, Boston, New York, Philadelphia, and every community in between. Wherever your business calls home—across the Pacific Northwest, the West Coast, or anywhere nationwide—Giesler-Tran Bookkeeping delivers expert financial clarity and trusted service in all 50 states.
This content is for educational purposes only and not intended as tax, legal, or financial advice. Consult a qualified professional for guidance specific to your business.