If you’re running a nonprofit or serving on a board, you’ve probably heard the terms “restricted funds” and “unrestricted funds” thrown around. Maybe you nodded along like you understood, but honestly weren’t quite sure what the distinction meant or why it mattered.
Here’s why it matters: a nonprofit can have a million dollars in the bank and still be broke. Not broke in the traditional sense; the cash is there. But if $900,000 of that money is restricted for specific purposes and you need to make payroll, you can’t touch it. Understanding the difference between restricted and unrestricted funds isn’t accounting trivia. It’s fundamental to knowing whether your organization can actually operate.
This gets even more confusing because the rules are different from for-profit accounting. In a regular business, revenue is revenue. In a nonprofit, revenue comes with strings attached or it doesn’t, and you have to track and report those strings carefully. Mess this up and you’ll misrepresent your financial position to your board, your funders, and potentially your auditors.
Let me break down exactly what these terms mean, how they work in practice, and how to account for them correctly.
Restricted funds are donations or grants that come with donor-imposed limitations on how you can use them. The donor says “here’s $50,000, but you can only use it for the after-school tutoring program” or “this grant is specifically for purchasing equipment, not for operating costs.”
The key word is donor-imposed. The restriction doesn’t come from your board deciding internally how to allocate money. It comes from the outside party who gave you the money placing conditions on the gift.
There are two types of restrictions:
Temporarily restricted (also called “with donor restrictions – time or purpose”) means the funds can only be used for a specific purpose, during a specific time period, or both. Once you meet those conditions, the restriction is satisfied and the funds become unrestricted. For example:
Permanently restricted (also called “with donor restrictions – perpetual”) means the original gift must be kept intact forever, but you can use the income it generates. This is almost always an endowment. For example:
The restriction isn’t about what you want to spend the money on. It’s about what you’re legally allowed to spend it on. Violating donor restrictions can have serious consequences; returned funds, damaged relationships, legal liability, and audit findings.
Unrestricted funds (also called “without donor restrictions”) are resources that have no external limitations on their use. Your board can decide how to spend them based on organizational priorities.
This includes:
Unrestricted doesn’t mean “unimportant” or “leftover money.” These are often your most valuable funds because they provide flexibility. They cover overhead, administrative costs, infrastructure, staff salaries, and all the things that keep your organization running but don’t make for compelling fundraising pitches.
Your board can internally designate unrestricted funds for specific purposes like building a reserve, funding a future program, setting aside money for capital improvements. These are called board-designated funds, and they’re still technically unrestricted. The board can change its mind and redesignate them at any time. This is completely different from donor restrictions, which you cannot unilaterally change.
The difference between restricted and unrestricted funds affects almost everything:
Cash flow management: You can have significant cash in the bank but no ability to pay your staff if it’s all restricted for other purposes. Organizations run into cash crunches not because they lack resources overall, but because they lack unrestricted resources.
Financial reporting: Your Statement of Financial Position (balance sheet) and Statement of Activities (income statement) must show restricted and unrestricted funds separately. This gives stakeholders a true picture of your financial flexibility.
Grant compliance: Spending restricted funds on the wrong things is a violation. Funders can ask for money back. If it’s a government grant, the consequences can be severe.
Board decision-making: Your board needs to understand how much of your resources are actually available for discretionary use versus locked up for specific purposes.
Fundraising strategy: Organizations that rely too heavily on restricted funding often struggle because they can’t cover core operating costs. You need a healthy mix.
Let’s walk through actual examples of how to record different types of donations and grants in your accounting system.
Your organization receives a $10,000 check from a donor with a note that says “Keep up the great work!” No restrictions, no conditions.
Journal Entry:
| Account | Debit | Credit |
| Cash | $10,000 | |
| Contributions – Unrestricted | $10,000 |
This increases your cash and increases your unrestricted revenue. Pretty straightforward. You can use this money for anything aligned with your mission.
A foundation awards you a $25,000 grant specifically to purchase laptops for your job training program.
When you receive the grant:
| Account | Debit | Credit |
| Cash | $25,000 | |
| Contributions – Temporarily Restricted | $25,000 |
At this point, the money sits in temporarily restricted net assets. You cannot spend it on anything other than laptops for the job training program.
When you purchase the laptops:
| Account | Debit | Credit |
| Computer Equipment | $25,000 | |
| Cash | $25,000 |
This records the asset purchase. But you also need to release the restriction because you’ve now satisfied the donor’s condition:
| Account | Debit | Credit |
| Net Assets Released from Restrictions – Temporarily Restricted | $25,000 | |
| Net Assets Released from Restrictions – Unrestricted | $25,000 |
This entry moves the funds from temporarily restricted to unrestricted on your Statement of Activities. The restriction has been satisfied; you bought the laptops as required.
A donor gives you $60,000 in January 2024 with instructions that it must be used over the next three years (2024, 2025, 2026) for general operations – $20,000 per year.
When you receive the donation in January 2024:
| Account | Debit | Credit |
| Cash | $60,000 | |
| Contributions – Temporarily Restricted | $60,000 |
At the end of 2024, you release the first year’s portion:
| Account | Debit | Credit |
| Net Assets Released from Restrictions – Temporarily Restricted | $20,000 | |
| Net Assets Released from Restrictions – Unrestricted | $20,000 |
You’ll make this same release entry in 2025 and 2026 as each year passes and the time restriction for that portion is satisfied.
A corporate sponsor gives you $50,000. The grant agreement specifies that $35,000 must be used for your literacy program, and $15,000 can be used for general operations.
When you receive the grant:
| Account | Debit | Credit |
| Cash | $50,000 | |
| Contributions – Temporarily Restricted | $35,000 | |
| Contributions – Unrestricted | $15,000 |
You’ve split the revenue into two categories based on the donor’s specifications. The $15,000 is immediately available for general use. The $35,000 can only be spent on the literacy program and must be tracked separately.
A donor makes a $100,000 gift to establish an endowment. The principal must remain invested permanently, but your organization can use the investment income for general operations.
When you receive the endowment donation:
| Account | Debit | Credit |
| Cash | $100,000 | |
| Contributions – Permanently Restricted | $100,000 |
When you invest the funds:
| Account | Debit | Credit |
| Investments – Permanently Restricted | $100,000 | |
| Cash | $100,000 |
When the investments earn $4,000 in returns:
This depends on the donor’s instructions. If they said investment income is unrestricted:
| Account | Debit | Credit |
| Cash | $4,000 | |
| Investment Income – Unrestricted | $4,000 |
If they said investment income must support a specific program:
| Account | Debit | Credit |
| Cash | $4,000 | |
| Investment Income – Temporarily Restricted | $4,000 |
The original $100,000 principal stays permanently restricted forever. Only the earnings can be spent.
You receive a $40,000 grant to run a mental health counseling program. The grant covers both direct program costs (counselor salaries, supplies) and some allocated overhead (rent, utilities).
When you receive the grant:
| Account | Debit | Credit |
| Cash | $40,000 | |
| Contributions – Temporarily Restricted | $40,000 |
Throughout the year as you incur program expenses:
Let’s say in March you pay $3,000 in counselor salaries and $500 in supplies for the mental health program:
| Account | Debit | Credit |
| Salaries Expense – Mental Health Program | $3,000 | |
| Supplies Expense – Mental Health Program | $500 | |
| Cash | $3,500 |
At the same time (or month-end), you release the restriction:
| Account | Debit | Credit |
| Net Assets Released from Restrictions – Temporarily Restricted | $3,500 | |
| Net Assets Released from Restrictions – Unrestricted | $3,500 |
You continue this pattern each month as you spend down the grant. By the time you’ve spent all $40,000 on approved program costs, you’ll have released all $40,000 from restrictions.
How This Shows Up in Your Financial Statements
The whole point of tracking these restrictions is so your financial statements accurately reflect your organization’s real financial position.
Statement of Financial Position (Balance Sheet)
Your net assets section will show three categories:
| NET ASSETS | |
| Without Donor Restrictions | |
| Undesignated | $150,000 |
| Board-designated operating reserve | $75,000 |
| Total Without Donor Restrictions | $225,000 |
| With Donor Restrictions | |
| Purpose restrictions | $85,000 |
| Time restrictions | $40,000 |
| Perpetual in nature (endowments) | $500,000 |
| Total With Donor Restrictions | $625,000 |
| TOTAL NET ASSETS | $850,000 |
This tells anyone reading your financials that while you have $850,000 in total net assets, only $225,000 is actually available for general use. The other $625,000 has strings attached.
Statement of Activities (Income Statement)
Revenue and releases from restrictions show separately:
| REVENUE AND SUPPORT | |
| Without Donor Restrictions | |
| Contributions and grants | $180,000 |
| Program service fees | $95,000 |
| Special events (net) | $45,000 |
| Investment income | $12,000 |
| Net assets released from restrictions | $120,000 |
| Total Without Donor Restrictions | $452,000 |
| With Donor Restrictions | |
| Contributions and grants | $200,000 |
| Investment income on endowments | $20,000 |
| Net assets released from restrictions | ($120,000) |
| Total With Donor Restrictions | $100,000 |
| TOTAL REVENUE AND SUPPORT | $552,000 |
The release entries appear as a positive amount in the unrestricted column and a negative amount in the restricted column. They’re internal transfers, not new revenue, showing that restrictions were satisfied.
The Board Designation Mix-Up
I’ve seen this happen more times than I can count. Your board meets and decides to set aside $50,000 for a future building project. The treasurer tells the bookkeeper to “make sure that money is restricted.”
Here’s the problem: that’s not a donor restriction. The board made that choice internally. They can unmake it tomorrow if they want. But if you record it as restricted funds in your financial statements, you’re lying to anyone who reads them – donors, grantmakers, auditors, everyone.
What you’re supposed to do is keep it in unrestricted net assets, just note it as “board-designated for building project.” It shows up in the unrestricted section of your balance sheet, maybe broken out as a separate line if you want to highlight it. But it’s not restricted. Your board has full authority to change that designation anytime.
Forgetting to Release the Restriction
This one drives auditors crazy. You get a grant for your summer camp program. You run the camp, you spend the money exactly as required, everything’s fine. But your bookkeeper never records the release entry.
Fast forward to year-end and your restricted fund balance is inflated by $25,000 that shouldn’t be there anymore. Your unrestricted balance looks artificially low. Your board thinks you have less operational flexibility than you actually do. And when the auditor shows up, they have to make an adjusting entry to fix it.
The release should happen in the same period you incur the expenses. If you spent $5,000 on camp expenses in June using grant funds, you record a $5,000 release in June. It’s not some year-end cleanup task; it’s part of regular monthly accounting.
“Borrowing” from Restricted Funds
This is where organizations get into real trouble. You’ve got $30,000 sitting in the bank from a youth program grant, but you’re short on cash for payroll. So you think “I’ll just use this temporarily and pay it back next month when our fundraising event money comes in.”
Don’t do this. Seriously, don’t. Even if you’re absolutely certain you’ll pay it back, even if it’s just for a week, even if the alternative is missing payroll, don’t do it.
Using restricted funds for unauthorized purposes is a violation of donor intent. Depending on the grant terms, it might be a breach of contract. If it’s a government grant, you’re looking at potential fraud allegations. And if you get audited before you’ve paid it back, you’ve got a major finding on your hands.
If you’re short on unrestricted cash, the answer is to fundraise for general operating support, cut expenses, or negotiate with vendors, not to raid restricted funds. I know that’s not what struggling nonprofits want to hear, but the consequences of violating restrictions are worse than the temporary cash crunch.
Not Actually Reading the Grant Agreement
A foundation gives you a grant and the agreement says funds can be used for “program and related administrative costs.” Your executive director figures that means you can allocate 30% to overhead since that’s your standard indirect rate.
But then someone actually reads the grant agreement and discovers that “related administrative costs” is defined specifically as direct program management salary only; not facilities, not general admin, not your portion of the ED’s time. Just the program manager.
Now you’ve spent the grant wrong. You have to either reimburse the funder from unrestricted funds or go back and renegotiate (embarrassing and not always successful). This could have been avoided by carefully reading the agreement before spending a dime.
Grant agreements aren’t all the same. Each one defines what’s allowable slightly differently. You can’t make assumptions. Someone needs to actually read every agreement, understand what it allows and what it doesn’t, and communicate that clearly to whoever’s charging expenses against it.
Sloppy Documentation
Throughout the year, your organization receives dozens of donations. Some are clearly unrestricted – cash in the offering plate, general donations through your website. Some come with letters specifying exactly how they should be used. Some are ambiguous.
But nobody’s really tracking it carefully. Donations get entered into QuickBooks with vague descriptions. The letters from donors get filed (maybe) but aren’t connected to the accounting entries. Your donation database and your accounting system don’t talk to each other.
Come December, you’re trying to prepare year-end financials and you’re basically guessing about what should be classified as restricted. You think that one $10,000 check was for the scholarship fund, but you’re not sure. Was that $5,000 from the gala unrestricted or did you promise it would go to program X?
This is fixable with basic systems. When a donation comes in, note any restrictions right then; in your donation software, in the memo field of the accounting entry, somewhere easily accessible. Attach the grant agreement or donor letter to the transaction. Keep a simple tracking spreadsheet showing each restricted grant, what it’s for, how much you’ve spent, and when the restriction will be satisfied.
You don’t need sophisticated software. You just need to consistently document restrictions when money comes in, not try to reconstruct it months later from memory.
Here’s what works in real nonprofits:
Set up your accounting software properly. Whether you’re using QuickBooks for Nonprofits, Aplos, Sage Intacct, or something else, take the time to configure it for fund accounting or at least use class tracking to separate restricted from unrestricted activity. Most nonprofit software supports this – you just have to actually use the feature.
Keep a grant tracker. I’m talking about a simple spreadsheet or database with these columns: grant name, funder, total amount, date received, restrictions/purpose, spending deadline (if any), amount spent to date, remaining balance. Update it monthly when you close the books. This gives you a quick reference for what restrictions exist and helps you avoid spending deadline surprises.
Talk to your board in plain language. Board members often don’t understand the difference between total net assets and unrestricted net assets. When you present financials, point out explicitly: “We have $850,000 in total net assets, but $625,000 of that is restricted for specific purposes. We have $225,000 available for general operations.”
Many board decisions get made incorrectly because board members think the organization has more flexibility than it actually does. Make this crystal clear in every financial presentation.
Actually pursue unrestricted funding. I know restricted grants are easier to win because funders like to see their money go to specific programs. But if your entire budget is restricted funding, you can’t keep the lights on. You need to actively cultivate donors who give to general operations, price your programs to cover their full cost including overhead, and communicate honestly about the importance of unrestricted support.
Be careful what you promise. When a donor asks if their $20,000 gift can be designated for X, and you’re not 100% sure you’ll be doing X or that X will cost $20,000, don’t just say yes to secure the donation. An unrestricted $20,000 is way more valuable than a restricted $20,000 you struggle to spend appropriately. It’s okay to explain to donors that unrestricted gifts give you the most flexibility to respond to community needs.
Review your restricted balances quarterly, not just annually. At least four times a year, look at what restrictions you’re carrying. Are there any that should have been released but weren’t? Are there grants with spending deadlines approaching that you need to use? Are there old restrictions sitting on your books that maybe need to be addressed with the donor?
This kind of regular housekeeping prevents the year-end scramble and helps you actually use restricted funds for their intended purposes before deadlines pass.
Look, if you’re a small all-volunteer organization with a few unrestricted donations and no grants, you can probably handle this yourself with decent accounting software and careful attention to the basics.
But once you’re managing multiple restricted grants, dealing with endowments, navigating complex compliance requirements, or preparing for audits; that’s when basic bookkeeping isn’t enough anymore. You need someone who actually knows nonprofit accounting standards, who’s set up these systems before, and who can spot problems before they become audit findings.
The organizations that get this right aren’t necessarily the ones with the biggest budgets. They’re the ones that recognized early that nonprofit accounting is genuinely different from small business accounting, and they got appropriate help before making expensive mistakes.
If your board is confused about your financial position, if you’re not confident about whether you’re tracking restrictions correctly, or if you’re about to go through your first audit, those are signs you need professional support, not just someone who knows QuickBooks.
At Quadrant Advisory, we work with nonprofits that are past the basics and need real expertise in fund accounting, grant compliance, and financial reporting that actually makes sense to boards and funders. If you’re trying to professionalize your finance function or if you’re just not sure you’re doing this right, we should talk.
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