How to Properly Manage Restricted Funds at Your Nonprofit

by Brittany LaGanke, Vice President, Project Management, CGC

Nonprofit income is often made up of many different revenue streams, such as grants, individual giving, earned revenue, investment returns, and corporate philanthropy. Documenting income sources is an important step in establishing proper financial management, as well as planning for the future and acknowledging supporters.

In addition to documenting where your nonprofit’s money comes from, there is another critical recordkeeping factor when it comes to nonprofit income: whether the funds are restricted. Restricted income requires specific management practices that your nonprofit needs to follow. We’ll cover what these procedures include, as well as other helpful tips, in this guide.

What are restricted funds?

Restricted funds are contributions to your nonprofit that come with stipulations for how they should be used. Contributors are in charge of establishing restrictions—examples include:

Capital campaign contributions: When your nonprofit runs a capital campaign to raise money for a major project (like a new building), gifts to it are restricted because donors have given them for the specific purpose of supporting that project.
Grants: Many grants fall into the restricted funds category because they have specific use cases outlined in their application requirements and because grantmakers expect you to spend them as outlined in your proposal.
Any individual or corporate giving earmarked for a purpose: Donors might feel passionately about a specific initiative within your nonprofit and want all of their money to go toward it. These contributions could look like:
- A bequest designated for the operation of a certain program
- A major gift to fund a research initiative
- An event sponsorship from a local business

Restricted funds can be temporarily or permanently restricted. If a fund is temporarily restricted, that means the donor’s restrictions are bound by time or purpose, which could expire. The examples above are usually temporarily restricted funds.

An endowment, on the other hand, is a common example of a permanently restricted fund. Infinite Giving’s guide to endowments defines them as “dedicated source[s] of long-term funding made up of donations that support a philanthropic organization’s mission and work.” If an endowment is restricted, your nonprofit can use the interest it earns for activities that support an ongoing initiative you’ve agreed on with the contributor(s). The original donation usually isn’t available for your nonprofit to spend directly.

Why are restricted funds important?

Supporters often attach stipulations to donations because of their individual passions and interests. They want to specifically support what matters to them, whether that’s a scholarship that provides academic opportunities they benefited from, medical research into a disease that’s affected their family, or an event that would put their CSR efforts on the map. Accepting and properly managing restricted funds is a core aspect of creating a strong donor stewardship strategy, building trust in your organization, and increasing engagement with your mission.

Additionally, when you give donors a sense of urgency and a milestone to connect with—like how renovating a wing of your museum to incorporate interactive exhibits will support educational initiatives within your community—it’s a compelling vision that makes them want to support your work. And since most restricted contributions are significant, they help build the capacity your nonprofit needs to make that vision and many others a reality.

However, the strings attached to restricted funds can make management complicated. You’ll need to categorize these contributions separately in your records and make note of them in financial reports, such as your nonprofit’s annual tax return and financial statements. The additional team time and resources you spend to ensure fiscal compliance are the indirect costs of accepting restricted funds.

These indirect costs don’t outweigh the benefits of accepting restricted funds, but your nonprofit should be aware of them and the consequences of improperly handling these contributions. Mismanagement can result in broken donor trust, reputation damage, and even legal consequences like fines and lawsuits.

How should nonprofits manage restricted funds?

Being clear with your donors and team is the most effective way to make the entire experience of accepting restricted funds go smoothly. Jitasa’s guide to nonprofit financial management outlines recommended financial guidelines and policies, one of which is a gift acceptance policy. Your nonprofit should address restricted funds in your gift acceptance policy, including how, when, and what type of restricted funds your nonprofit can accept.

Here are a few additional tips for managing these contributions correctly.

Review donation agreements carefully.

In your nonprofit’s gift acceptance policy, you may require restricted fund gifts over a certain amount to have a formal donation agreement, or the donor may have a donation agreement prepared already. It’s important to review this document carefully, as it will be a binding agreement and contain the conditions for spending restricted funds. You might also include a provision for the fund’s use if the temporary restrictions expire (more on this later).

Identify funding restrictions on financial statements and forms.

Most nonprofit financial procedures are based on legal guidelines and specialized financial knowledge, as well as general common sense. The same goes for restricted fund management. Part of that legal compliance includes reporting restricted funds properly on the following financial statements and forms:

Statement of activities
Statement of financial position
Statement of cash flows
Form 990

To ensure your nonprofit can accurately report restricted funds on these statements and forms, note funding restrictions when you record contributions in your accounting system. Clear, consistent documentation makes reporting easier and increases transparency.

Budget restricted funds first.

After you’ve received and documented restricted funds, use them as the starting point for your operating budget. You already know where to allocate them, and budgeting them first helps ensure you use them correctly. Then, you can fill in the gaps in your programs and overhead with unrestricted funding.

For example, a school may have budgeted $5,000 for fall semester extracurriculars. The most recent round of student-led product fundraisers generated $2,000 to support extracurriculars, and a donor matched that amount with a restricted contribution. By allocating this designated revenue first, the school’s financial team would know they’d need an additional $1,000 from their annual fund for this budget category.

Make provisions for leftover restricted funds.

If the intended purpose of temporarily restricted funds is fulfilled or a deadline expires, your nonprofit could potentially have money left over but be unable to spend it in accordance with the original restrictions. In those circumstances, you could:

Completely release the funding from restriction and spend it however your nonprofit needs the most.
Reallocate the leftover revenue to another initiative that the donor is also passionate about.
Return the extra funds to the contributor.

Include a provision in each donation agreement your organization makes stipulating which of the above options will apply to those restricted funds. If you have questions about managing restricted funds at your nonprofit, it’s best to check with a nonprofit financial professional, who can speak to the requirements that apply in your specific situation.

Restricted funds are just one of the many ways that your community can support your mission. Through careful documentation, compliance, and communication, your nonprofit can effectively manage these contributions, building a foundation of trust in the supporter base that allows you to further your mission.