Imagine this: A donor uses one of your nonprofit’s donation tools to make a substantial gift, which is much-needed for your operational expenses. You immediately have big plans for the contribution, but soon realize that the donor made a specific request for how the gift is used.

Restricted funds are designated donations set aside for a particular purpose that can’t be used for another nonprofit expense. This means they must be used for the donor-designated purpose, or else your organization could risk penalties, lawsuits, or revocation of its tax-exempt status.

To ensure you handle restricted funds properly, we’ve compiled this checklist of steps to take. Let’s explore what your nonprofit can do to manage these donations.

1. Understand limitations.

To comply with donors’ restrictions, you must first understand the limitations on these donations upon receiving them. A thorough understanding helps you evaluate the type of restriction placed on the contributions and ensures you don’t accidentally misappropriate funds.

For example, let’s say a donor contributes $200,000 to a project that will only cost $100,000. You’ll have limited use for this gift, meaning the donor must change their restrictions or your nonprofit must refuse the donation altogether.

However, there are other types of restrictions placed on donations, such as the purpose of the contribution and the type of gift given. Some of these restrictions include:

  • Programmatic restrictions: These are donations that are meant to be spent on specific programs. For example, an environmental conservation group might receive a donation meant solely to fund the organization’s tree-planting efforts.
  • Restricted operating funds: These restricted gifts are designated for an organization’s operating expenses, such as the cost of rent and utilities.
  • Endowment restrictions: NXUnite’s guide to nonprofit endowments describes them as “a pool of donations set aside and invested, allowing it to grow and financially support the work of a philanthropic organization.” These gifts may be temporarily or permanently restricted, although most restrictions are usually permanent. This means both the principal amount and resulting interest are subject to the donor’s conditions.
  • Restricted grants: Many grants are offered for specific initiatives or purposes. For example, eligible nonprofits receive $10,000 monthly in free ad credits through the Google Ad Grant—not a check for $10,000. This means they can only spend the grant on Google Ad campaigns.

Taking the time to understand the types of restricted funds you receive and the details of their restrictions will help your organization properly make use of them. This way, you can use the funding to fulfill donors’ wishes and further your mission at the same time.

2. Account for the restricted donation.

After accepting and evaluating restricted funds, your nonprofit should record these donations in its accounting system. These restrictions should be noted in the following records:

  • Income statement: Your nonprofit should already record each donation it receives, and your income statement is the primary source for recording details about these funds. Display restricted funds in a separate column for a comprehensive view of which income is liquid and which is limited.
  • Statement of activities: Foundation Group’s bookkeeping guide defines this as a report of where revenue came from and how it was used. It should be split into three categories: revenue, expenses, and net assets. To account for restrictions, further break down each category into unrestricted, temporarily restricted, and total funds.
  • Statement of financial position: This statement shows your organization’s assets, liabilities, and net assets. Divide net assets into funding with and without donor restrictions.

Recording restrictions this way allows your nonprofit to understand the liquidity of its funding. Then, you’ll have the context needed to start allocating these funds and putting them to work for your mission.

3. Budget according to restricted funds.

Especially when restricted funds are unsolicited, your nonprofit may have to readjust its fund allocation. For example, if a donor gives a restricted gift of $50,000 to your project that requires $100,000 in funding, your nonprofit must fundraise to cover the rest of that cost.

After receiving and recording restricted funds, it’s time to apply them to your budget. Allocate funds according to their restrictions, then determine what additional funds you’ll need to raise to cover your expenses. For example, your expenses may look something like this:

  • Operational costs: These are the costs of running your nonprofit, which are often covered by the funds you raise through various initiatives.
  • Fundraising expenses: These are the costs incurred by fundraising events and campaigns, such as the amount you spend while cultivating corporate donations or hosting a fundraising gala.
  • Programs: These refer to the cost of your nonprofit’s work. For example, an animal shelter may raise funds for its veterinary care program, which provides health services for the animals in its care.

Let’s say a donor requests their contribution be used solely for one of your programs. In this case, you may have to host more fundraising campaigns to cover your operational expenses. On the flip side, restricted funds may cover your recurring expenses, freeing up unrestricted funds to build your operating reserves or otherwise support your nonprofit’s financial goals.

In other words, aligning your budget with restricted funds enables you to use donations for their intended purposes while also meeting your other funding needs.

4. Report use and impact.

Transparency is a cornerstone of nonprofit bookkeeping, which is why you should share detailed information on the restricted funds you’ve raised, the way you’ve spent them, and the outcomes you’ve achieved with them. Donors, board members, and other key stakeholders want to know how your nonprofit spends its funding and what impact their support was able to make!

Here are a few ways you can share this information:

  • Your website: Create a dedicated page on your nonprofit’s website for restricted donations. Explain what they are and how your nonprofit uses them. You might even provide details about which of your programs could use more funding so that donors who want to give a restricted gift know which areas your nonprofit needs help in.
  • Annual reports: Include information about your use of restricted gifts and the impact you were able to make with them in your annual report. Here, you can tell specific stories about your nonprofit’s work and draw connections between donors’ contributions and your accomplishments.
  • Social media posts: While this content may not be as fleshed out as a dedicated website page or annual report, social media posts can provide quick snippets of information about your use of restricted funds. Provide statistics where relevant and highlight impactful facts with visually appealing posts.

You may even create a dedicated report with an overview of restricted funds, depending on how much of your overall revenue is made up by this type of giving. This can provide donors with more insight into your organization’s approach to budgeting, as well as remind them that you’re keeping their requests top of mind in your operations!

As you build a budget based on your nonprofit’s restricted funds, work with various team members for a comprehensive overview of what it takes to run your nonprofit. Those who interact directly with a program’s expenses, for example, will have a better understanding of what funding is needed and how to predict future expenses. Equipped with this guidance, you’ll be able to make the most of both unrestricted and restricted funds.