Restricted Funds: How to Handle Them

Your donors have the right to set restrictions on the donations they give. Grant funders want to make sure their funds are spent on agreed-upon programs. You have to ensure these funds are spent in a way that supporters approve of.

Restricted funds ensure that donors alone can direct the usage of their assets. Failure to comply with restrictions can result in legal action. Fund designations are specified in writing or through other agreement. Your nonprofit can avoid confusion by offering a choice of designation.

Restricted funds must be accounted for separately in your nonprofit’s financial statements. When budgeting, you should separate restricted and unrestricted funds so that you allocate the money you have to spend correctly.

With permanently restricted funds, the donation acts as principal on which interest can be earned and only the interest is to be spent. Temporarily restricted funds specify a time frame during which the funds must be used for a specific purpose, and then they become unrestricted funds, which can be spent on whatever your nonprofit sees as its greatest need.

Endowments are considered restricted funds. The principal cannot be spent and only a specified percent of the interest can be used. The interest may be specified only to fund scholarships and professorships, for example.

When donors restrict their contributions to specific purposes and programs, you need to make sure that the restrictions remain obvious because, too often, temporarily restricted funds are out of mind until cash flow needs are tight. Maintaining an up-to-date net asset schedule allows you to have a better idea of what funds are available to budget for your operating needs.

Fund accounting lets nonprofits allocate money into different groups and to keep them organized so that you only spend funds on what they’re designated for. Generally accepted accounting principles (GAAP) rules for nonprofits are intended to create transparency for donors and grant-makers, as well as helping the government monitor whether your nonprofit should retain its tax-exempt status.

Know the rules and best practices

Nonprofit financial managers need to:

• Label net assets — are they restricted, either by donors or grant conditions, or unrestricted?
• Show any limitations or restrictions that impact their cash flow.

Donations should be something your accountant and accounting staff monitor closely and record in compliance with GAAP. Record promises of future donations when you receive the pledge, rather than when you receive the actual donation.

Keep top of mind these challenges to your financial picture:

• If you lack real-time financial data, you may end up with periodic or inaccurate management reports. And that means financial statements are less useful because they have outdated data.
• With accurate management reports, detailed expense reports for event mission-based budgets let you focus on finding better funding sources. Accountants can help you manage reporting.
• Are you using paper documentation? Avoid outdated accounting and find the right software. Turn to a pro nonprofit bookkeeper for workflow, managed reports and real-time financial info. An accounting professional can save valuable time for your organization.
• Tracking grants: When applying for grants, there are many steps involved. Track grants applied for or received by hiring a specialist and/or work with software to streamline reporting.
• Cybersecurity directly impacts financial security:
  • Limit access to financial information.
  • Update security features.
  • Keep your info safe.
  • Use professional monitoring of your accounts. An experienced eye is more likely to notice any disparities sooner.
• Payroll management: Look to an external payroll bookkeeper to remove any issues in tracking sources of income and disbursal of funds. This will ensure you have a reliable system for paying employees.
  • If your nonprofit’s finances ever come under audit, you need payroll management.
• Board oversight: Your board may bring financial advice to support your group but adds more steps to reporting processes, and that can generate more errors in reporting.
  • Board members may ask about budgeting, assets and expenses. An accountant can answer complicated queries.
  • A nondistribution constraint helps define nonprofits. Nonprofits are required not to distribute net earnings to leaders. Say your group found an extra $10,000 in its budget — you are not supposed to distribute the funds to executives or board members. Instead, reinvest these funds in the group’s mission.
• The Financial Accounting Standards Board (FASB) compliance: The regulations for 501(c)(3) groups change annually — sometimes more than once a year. Make sure you’re on top of your books so you avoid falling out of compliance. You don’t want to lose nonprofit status from a small mistake.

Nonprofits need to plan, record and report finances, focusing on being accountable to donors and contributors. Call our office to aid your nonprofit with its myriad financial reporting requirements.

To learn more about how our firm can serve your nonprofit organization, don’t hesitate to contact Kathy Corcoran at (302) 254-8240.

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