Your nonprofit receives a generous donation, and suddenly there's more money in the bank.
That's good news, right?
Absolutely. But here's an important question:
Can your organization actually spend that money on whatever it needs?
Not necessarily.
One of the most important parts of nonprofit financial management is understanding the difference between restricted and unrestricted funds.
When nonprofit leaders don't understand these distinctions, they can unintentionally create cash flow problems, inaccurate financial reports, and difficulties maintaining donor trust.
Let's break down what you need to know.
What Are Restricted Funds in Nonprofit Accounting?
Restricted funds are contributions that come with specific requirements established by the donor.
These restrictions may determine when the money can be used, what it can be used for, or whether certain assets must be maintained over time.
For example, imagine someone gives your nonprofit $25,000 specifically to purchase equipment for a new community outreach program.
That donation is not simply available to pay general operating expenses.
It was given for a particular purpose, and your organization needs to account for it accordingly.
Common examples of donor-restricted contributions include:
Donations designated for a building project
Contributions restricted to a specific program
Scholarship funds
Certain grant awards
Gifts designated for future periods
Endowment contributions
The key is understanding the donor's actual instructions and keeping appropriate documentation.
What Are Unrestricted Funds?
Unrestricted funds are resources that are not subject to donor-imposed restrictions.
These funds generally provide greater flexibility for supporting the organization's mission and operations.
For example, unrestricted contributions may help cover:
Staff salaries
Rent and utilities
Administrative expenses
Technology and equipment
Program operations
General organizational needs
Unrestricted funding is especially valuable because nonprofit organizations need resources to maintain everyday operations—not just fund specific projects.
A nonprofit can have significant donations coming in and still struggle financially if most of those resources are restricted.
Restricted vs. Unrestricted Funds: A Simple Example
Imagine your nonprofit has $100,000 in cash.
At first glance, that may seem like a strong financial position.
But let's look more closely.
Of that amount:
$50,000 came from donations restricted to a building project.
$20,000 came from a contribution designated for a scholarship program.
$30,000 is available for general operations.
Although the nonprofit has $100,000 in its bank account, only $30,000 of that amount is unrestricted cash available for its general operating needs.
This is a simplified example, but it illustrates why nonprofit leaders need to understand more than their bank balance.
Money in the bank does not automatically mean money available to spend.
How Should Nonprofits Track Restricted Funds?
Accurate nonprofit bookkeeping is essential for managing donor restrictions.
Your accounting system should allow you to identify contributions that have restrictions and monitor whether those restrictions have been satisfied.
Depending on the organization and its accounting software, this may involve tracking activity by:
Fund
Program
Project
Grant
Donor restriction
Department or location
For example, if your nonprofit receives a restricted contribution for a community program, you should be able to identify the related revenue and expenditures.
This helps leadership understand whether money is being used appropriately and how much remains available for its intended purpose.
It's also important to retain donor agreements, grant documents, and other records that explain the restrictions.
What Happens When a Restriction Is Satisfied?
Some donor restrictions apply only until a specific event occurs or a particular purpose is fulfilled.
For example, a donor may give $10,000 to purchase supplies for a youth program.
As qualifying supplies are purchased and the restriction is satisfied, the nonprofit's accounting records may need to reflect a release from restriction.
Under nonprofit financial reporting standards, this generally involves reclassifying the applicable net assets from with donor restrictions to without donor restrictions.
The timing and accounting treatment depend on the contribution terms and the applicable accounting guidance.
The important point is that restricted contributions require ongoing attention, not simply accurate recording when the donation first arrives.
What About Money Set Aside by the Board?
Here's another distinction nonprofit leaders should understand.
Sometimes a nonprofit board decides to reserve money for a particular future need.
For example, the board may designate $40,000 toward future building repairs.
That is different from a donor restricting a contribution.
The board's decision creates an internal designation rather than a donor-imposed restriction.
In financial reporting, board-designated amounts generally remain classified as net assets without donor restrictions, even though leadership has decided to set them aside.
Understanding this difference helps keep financial statements accurate.
Common Mistakes Nonprofits Make With Restricted Funds
1. Treating all donations as available cash
Receiving a donation doesn't automatically mean the organization can use it for any expense.
Donor restrictions need to be identified and documented.
2. Failing to track restricted contributions separately
When restricted and unrestricted activity isn't properly identified in the accounting system, it becomes difficult to determine how much money is available for each purpose.
3. Confusing board-designated funds with donor-restricted funds
Internal decisions about how to use money aren't necessarily the same as restrictions established by donors.
4. Not reviewing restrictions regularly
Nonprofits should periodically review which restrictions remain in place and which have been satisfied.
5. Assuming a healthy bank balance means healthy cash flow
An organization may have substantial cash while facing a shortage of resources available for general operations.
Reviewing available cash alongside restrictions and upcoming obligations provides a more useful picture.
What Financial Reports Should Nonprofit Leaders Review?
Nonprofit boards and leadership teams should have access to reliable financial information.
Important reports may include:
Statement of Financial Position
Shows assets, liabilities, and net assets, including classifications with and without donor restrictions.
Statement of Activities
Shows revenue, expenses, and changes in net assets during a reporting period.
Budget vs. Actual Report
Helps leadership compare financial activity with the organization's approved plan.
Cash Flow Information
Helps leaders understand the timing of money coming into and going out of the organization.
Restricted Fund or Grant Reports
Provide additional detail on contributions, spending, remaining resources, and applicable restrictions.
These reports work together to help leadership make informed financial decisions.
How Can Nonprofits Improve Restricted Fund Management?
A few consistent practices can make a significant difference.
Document restrictions when donations arrive
Review donation agreements, grant awards, and written donor communications.
Don't rely on memory when determining how contributions may be used.
Build the right accounting structure
Use appropriate accounting categories and tracking features so restricted activity can be reviewed accurately.
Review restricted balances monthly
Don't wait until year-end to discover that funds were categorized incorrectly or spent outside their intended purpose.
Provide meaningful reports to leadership
Make sure board members and organizational leaders understand the distinction between total resources and resources available for current operations.
Get help when financial reporting becomes complicated
As an organization grows, grant management, donor restrictions, and financial reporting can become increasingly complex.
Having knowledgeable accounting support can help ensure the system grows with the organization.
Frequently Asked Questions
Can nonprofits use restricted donations for operating expenses?
Only when the expenses are consistent with the donor's restriction or another legally permitted use. For example, a donation restricted to a particular program may support qualifying program expenses, but it generally cannot simply be redirected toward unrelated operating needs.
Do restricted funds need a separate bank account?
Not necessarily. An organization can often track donor restrictions through its accounting records, although particular grants, agreements, or legal requirements may call for separate accounts.
Accurate tracking is essential regardless of where the cash is deposited.
Can a nonprofit change the purpose of a restricted donation?
A nonprofit should not unilaterally change a donor's restriction. Changes may require donor consent or an applicable legal process, depending on the circumstances.
Are restricted and unrestricted funds reported differently?
Yes. Under U.S. nonprofit accounting standards, net assets are generally presented in two categories: with donor restrictions and without donor restrictions.
Final Thoughts
Understanding restricted and unrestricted funds is an essential part of responsible nonprofit financial management.
Accurate tracking helps protect donor intent, improve financial reporting, and support informed decisions.
But just as importantly, it helps nonprofit leaders understand what resources are actually available to carry out their mission.
Because strong financial stewardship isn't just about knowing how much money your organization has.
It's about knowing how that money can be used—and making sure your systems support the mission you've been entrusted with.
Need Help With Your Nonprofit Accounting?
At Accountability Plus, we help nonprofit organizations create organized financial systems, improve bookkeeping processes, and understand their financial information.
Whether your organization needs help with financial reporting, accounting systems, or establishing better bookkeeping practices, we're here to help.