Restricted vs. Unrestricted Funds
Worrisome, sure. Difficult, it doesn’t need to be.
The Problem
The Scenario: A donor makes a $5,000 donation that must be used to purchase backpacks for your summer reading program. You’re thrilled with the donation, but not sure how to ensure this money is not used for other purposes. Do you need a separate bank account? Do you need a new credit card account? What reports are needed to prove you comply with the request?
While getting the donation is great, tracking "restricted" funds must be done correctly. This is one of the biggest headaches for a small nonprofit organization. Your credibility, and therefore your ability to acquire future donations, depends on it.
This is what “Fund Accounting” is all about.
This post will break down the difference between Restricted and Unrestricted funds in plain English. It will provide you with a simple system of tracking them, and a better night’s sleep.
What’s the Difference anyway?
Unrestricted Funds
This is money where the organization chooses what the money is spent on. No strings are attached. Here, the donor trusts you to use it wisely, and where it’s needed most (rent, utilities, staff salaries, general supplies). These are real expenses that must be paid. However, these donations are generally the hardest to obtain. People are more likely to support a program they are feel passionate about rather than the organization as a whole.
Restricted Funds
This is money given for a specific purpose, project, or timeframe.
The donor sets a restriction. You are required to their donation in the manner they stated.
Spending restricted money on the wrong thing isn’t just bad etiquette—it can violate the law and jeopardize your 501(c)(3) status.
The Mental Shift — Think "Classes", Not Bank Accounts
A Common Mistake is opening a brand-new bank account for each restricted fund.
This significantly complicates your bookkeeping.
It requires the bookkeeper to reconcile a different set of accounts for each restriction.
Deposits that are for multiple programs require bank transfers to keep the bank accounts matching the bookkeeping accounts.
It requires an increase in the number of accounts in your bookkeeping system. This makes your reports more complicated and harder to read.
A Better Solution: Set up your Accounting Software to use “classes” not bank accounts.
Your Chart of Accounts:
Setup your Chart of Accounts to separate Restricted Donations from Unrestricted Donations..
QuickBooks uses "Classes" to do this.
Using Classes allows you to put all of your expenses in their natural category, and then subdivide the expenses by their restriction.
The Magic Report — The Statement of Functional Expenses
Attached is a copy of a Statement of Functional Expenses. In this example, the organization has 3 programs: Youth Mentoring, Community Pantry, and Job Training.
All expenses are identified as either Program, Admin, or Fundraising expenses. Fundraising expenses are further broken down by program. This information is required to complete their 990 at the end of the year.
In this example, their Revenue is also broken down by program. This information is not required for their 990, but it is helpful to the board when making financial decisions about each program.
Here I am using “Classes” because that is what QuickBooks uses. Other programs may use a different term, but the functionality is the same. All Office Expenses will be categorized as an Office Expense, but the Office Expense will be divided their class.
Conclusion
Allowing donors to place restrictions on donations increases their desire to give. Complying with these restrictions is a challenging task, and can cause many sleepless nights. However, with your books setup properly this can be a simple task.
We specialize in helping small nonprofits organize their books and build stress-free accounting procedures. Schedule a free consultation with us. It will change your future!
