Restricted funds explained for charities and not-for-profits

Restricted funds are an important concept for charities and not-for-profits to understand.

At first glance, restricted funds can look like ordinary money in the bank. But they are not always available for general operating costs. If money has been given for a specific purpose, program, project or condition, the organisation may only be able to use it for that purpose.

This matters because many not-for-profits rely on grant funding, donor appeals, sponsorships, government funding, philanthropy or project-based income. Some of that funding may be restricted. If it is mixed with general operating cash and not tracked carefully, the board may misunderstand the organisation’s true financial position.

A charity may appear to have a healthy bank balance while still having limited unrestricted cash available for wages, rent, administration or general operating costs.

Restricted funds are not a problem when they are managed well. They can support important programs and give funders confidence that money is being used as intended. But they do require clear records, careful reporting and strong financial oversight.

This article explains what restricted funds are, how they differ from unrestricted funds, why they need to be tracked carefully, and the common mistakes boards should avoid.

What are restricted funds?

Restricted funds are funds that must be used for a specific purpose.

The restriction may come from a grant agreement, donor condition, funding contract, appeal campaign, legal requirement or trust arrangement. The key point is that the organisation does not have full discretion to use the money however it chooses.

For example, a charity may receive:

• a grant to deliver a youth mentoring program
• a donation specifically for emergency relief
• funding to purchase equipment for a particular service
• a sponsorship tied to a specific event
• a government payment for a defined program
• funds raised through an appeal for a named purpose
• philanthropic funding with agreed outcomes and reporting conditions

In these cases, the organisation must use the money in line with the restriction or funding condition.

Restricted funds should be clearly identified in the accounting system and reported to the board in a way that shows how much has been received, how much has been spent and how much remains available for the restricted purpose.

Restricted funds versus unrestricted funds

The difference between restricted and unrestricted funds is simple but important.

Restricted funds

Restricted funds can only be used for the specific purpose attached to them.

For example, if a funder gives $80,000 for a mental health outreach program, the organisation generally cannot use that money to pay unrelated administration expenses unless the funding agreement allows it.

The restriction may relate to:

• what the money can be spent on
• which program it supports
• which location or community it is for
• which time period it must be used in
• which outcomes must be delivered
• what evidence must be kept
• when financial reports or acquittals are due

Restricted funds are often linked to grant funding, donor restrictions or contractual obligations.

Unrestricted funds

Unrestricted funds are funds the organisation can use more flexibly, provided they are used for the organisation’s purpose and in line with its rules.

Unrestricted funds may come from general donations, membership income, trading income, investment income, unrestricted fundraising or other income without specific conditions attached.

These funds may be used for general operating costs such as:

• wages
• rent
• insurance
• administration
• technology
• professional support
• general program delivery
• core operating expenses

Unrestricted funds are important because they give the organisation flexibility.

They are also central to financial reserves for not-for-profits, because genuine reserves usually need to be available for discretionary use rather than locked to a specific purpose.

Why restricted funds matter

Restricted funds matter because they affect what the organisation can actually afford.

A board may look at the bank balance and think there is enough money available. But if a large portion of that cash is restricted, the organisation may have less flexibility than it appears.

For example, a charity may have $300,000 in the bank, but:

• $180,000 is restricted grant funding for a specific program
• $40,000 is tied to a donor-funded equipment purchase
• $30,000 is awaiting acquittal
• only $50,000 is available for general operating costs

If the board only sees the total cash balance, it may make decisions based on a misleading picture.

Restricted funds matter because they affect:

• cash flow
• program delivery
• grant compliance
• financial reporting
• board decision-making
• risk management
• financial sustainability
• trust with funders and donors

This is why restricted funds should be part of regular board reporting, not only reviewed at year-end.

Common sources of restricted funding

Restricted funding can come from many sources.

Grant funding

Grant funding is one of the most common sources of restricted funds.

A grant agreement may specify:

• the program or activity to be delivered
• eligible expenses
• ineligible expenses
• budget categories
• delivery dates
• reporting dates
• outcomes or milestones
• evidence required for acquittal
• what happens to unspent funds

Not-for-profits should read grant agreements carefully before accepting funding. The board or management should understand whether the organisation has the capacity to deliver the activity and meet the reporting requirements.

Donor restrictions

Donors may give money for a specific purpose.

For example, a donor may give funds to support a scholarship, emergency relief program, building project or local service.

If the organisation accepts the gift on that basis, it should treat the funds according to the donor restriction.

Clear communication matters. Fundraising campaigns, donation forms and appeal wording should be carefully written so the organisation understands whether funds are restricted or unrestricted.

Appeals and fundraising campaigns

Money raised through an appeal may be restricted if the campaign tells donors the funds will be used for a specific purpose.

For example, if an appeal asks for donations to buy a vehicle for community transport, donors may reasonably expect the funds to be used for that purpose.

If the organisation wants flexibility, the appeal wording should make that clear.

Government funding agreements

Government funding often includes detailed conditions.

These may cover eligible spending, service delivery targets, reporting, records, audits, underspends, unspent funds and repayment obligations.

Because government funding can be complex, it should be tracked carefully in the accounting system.

Philanthropic and foundation funding

Philanthropic funders may provide grants for specific projects, capacity building, research, evaluation, infrastructure or service delivery.

These funds may come with reporting requirements, milestones and budget categories.

Even when the relationship with the funder is flexible, the organisation should keep clear records of what was agreed.

Why restricted funds need careful tracking

Restricted funds need careful tracking because the organisation may need to show that money was used correctly.

This may be required for:

• grant acquittals
• donor reporting
• board oversight
• annual financial reporting
• audit or review processes
• regulator expectations
• internal financial management
• future funding applications

If restricted funds are not tracked properly, the organisation may struggle to answer basic questions such as:

• How much restricted funding did we receive?
• What conditions apply?
• How much has been spent?
• What has it been spent on?
• How much remains?
• Is spending within the approved budget?
• Are we on track to deliver the funded activity?
• Is any money likely to be unspent?
• When is the acquittal due?

Good tracking protects the organisation and makes reporting easier.

Grant conditions and acquittals

An acquittal is a report that shows how grant funds were used.

It may include financial information, activity reports, outcomes, supporting documents and evidence that the organisation met the grant conditions.

Acquittals vary depending on the funder. Some are simple. Others are detailed and require specific reporting formats.

To prepare for acquittals, not-for-profits should keep records throughout the grant period, not scramble at the end.

Useful records may include:

• signed grant agreement
• approved budget
• funding conditions
• eligible and ineligible cost rules
• invoices and receipts
• payroll records for grant-funded staff
• timesheets or allocation records where needed
• program delivery records
• evidence of outcomes or milestones
• correspondence with the funder
• approved budget variations

Strong grant tracking also helps the board identify risks early. For example, if a grant is underspent halfway through the period, the organisation may need to adjust delivery, request a variation or plan how to manage unspent funds.

Restricted funds and financial reporting

Restricted funds should be visible in financial reporting.

How they are reported will depend on the organisation’s structure, accounting system, reporting obligations and accounting advice. But from a governance perspective, the board should be able to understand restricted funds clearly.

Useful reporting may include:

• restricted funds received
• restricted funds spent
• restricted funds remaining
• funding purpose
• grant or donor conditions
• delivery period
• acquittal or reporting deadline
• underspend or overspend risks
• unspent funds that may need to be returned

This reporting may sit alongside the profit and loss report, balance sheet, cash flow forecast and budget versus actual report.

For stronger not-for-profit financial reporting, restricted funding should not be hidden inside general income or general cash figures without explanation.

Restricted funds and cash flow

Restricted funds can affect cash flow in ways that are not obvious.

A grant may be paid upfront, in instalments or after milestones are met. Costs may occur before income is received. Funds may be received in one financial year but spent in another.

Boards need to understand both the funding condition and the timing of cash.

For example:

• A grant may be approved but not yet received.
• A payment may be delayed until a milestone is achieved.
• Funds may be received upfront but cannot be used for general costs.
• Unspent funds may need to be returned.
• Program costs may need to be paid before reimbursement is received.

This is why restricted funds should be reviewed alongside cash flow forecasts.

A board may see cash in the bank but still need to know how much is genuinely available for general operations.

For boards reviewing cash flow and reserves, financial reserves for not-for-profits explains why restricted funds should not be treated as discretionary reserves.

Governance risks of restricted funds

Restricted funds create governance risk when they are not understood or tracked.

Common risks include:

• spending funds outside the agreed purpose
• missing acquittal deadlines
• being unable to prove how funds were used
• accidentally using restricted funds for general operations
• overcommitting to programs without enough unrestricted support
• misreading the organisation’s true cash position
• damaging funder or donor trust
• having to return unspent or incorrectly spent funds
• audit or review issues
• poor board decisions based on incomplete reporting

These risks are not only finance team issues. They are governance issues.

Board members and Responsible People need enough information to understand whether restricted funds are being used properly and whether any risks need attention.

This connects with fiduciary duties, because board members are expected to protect the organisation’s purpose and resources.

Restricted funds and internal controls

Internal controls help make sure restricted funds are used correctly.

Practical controls may include:

• reviewing grant agreements before accepting funding
• setting up tracking codes or project codes in the accounting system
• keeping grant budgets separate from general operating budgets
• requiring approval before spending restricted funds
• checking expenses against eligible cost rules
• monitoring grant balances regularly
• keeping supporting documents attached to transactions
• reviewing acquittal deadlines
• requiring board approval for major variations or commitments
• reporting restricted funds to the board

These controls do not need to be complicated. They need to be consistent.

For practical examples of finance checks, see internal controls for charities.

How to track restricted funds in practice

The right tracking approach depends on the organisation’s accounting system and complexity.

Many organisations use project codes, tracking categories, classes, cost centres or separate ledger accounts to monitor restricted funding.

The aim is to separate restricted funds clearly enough that the organisation can report on them accurately.

A practical tracking process may include:

• recording each restricted funding agreement when it is received
• noting the purpose, amount and time period
• setting up a budget for the funded activity
• assigning a project or tracking code
• coding income to the correct restricted fund
• coding expenses to the correct restricted fund
• reviewing spending against budget each month
• monitoring unspent balances
• preparing acquittal reports from the same records
• closing or archiving the fund after final reporting is complete

The process should be clear enough that it does not depend on one person’s memory.

If a Finance Manager, Treasurer or bookkeeper leaves, the organisation should still be able to identify each restricted fund and its conditions.

What should the board see?

The board does not need every grant transaction in the board pack.

It does need a clear overview of material restricted funds and related risks.

A useful board report may show:

• name of funder or funding source
• purpose of funding
• amount received
• amount spent
• remaining balance
• delivery period
• reporting or acquittal deadline
• underspend or overspend risk
• key conditions or restrictions
• management comments

For example, a simple restricted funds table might show:

• Grant A: $120,000 received, $75,000 spent, $45,000 remaining, acquittal due 30 September.
• Appeal B: $35,000 received, $10,000 spent, $25,000 remaining for equipment purchase.
• Program C: $60,000 approved but not yet received, costs already commenced.

This helps the board understand both compliance and cash flow.

Common mistakes with restricted funds

Restricted funds are often misunderstood because they sit inside normal bank accounts and everyday finance processes.

A practical restricted funds checklist

Use this checklist to strengthen restricted funding oversight.

Before accepting restricted funding:

• Have we read the funding agreement or donor condition?
• Do we understand the purpose of the funds?
• Do we understand eligible and ineligible costs?
• Can we deliver the funded activity within the timeframe?
• Are overheads and administration costs covered?
• Are reporting and acquittal requirements realistic?
• Do we need board approval before accepting the funding?

When funds are received:

• Has the funding been recorded correctly?
• Has a project or tracking code been set up?
• Has the approved budget been entered?
• Are key dates recorded?
• Does the board know the funding has conditions?
• Are relevant staff aware of spending rules?

During delivery:

• Are expenses coded correctly?
• Is spending reviewed against the approved budget?
• Are supporting documents being kept?
• Are milestones and reporting dates being monitored?
• Are underspend or overspend risks being reported?
• Are variations approved before changes are made?

For board reporting:

• Can the board see restricted and unrestricted funds separately?
• Does the board know how much restricted funding remains?
• Are acquittal deadlines visible?
• Are unspent funds or repayment risks identified?
• Are restricted funds included in cash flow discussions?

At completion:

• Has the acquittal been prepared and submitted?
• Have all supporting documents been retained?
• Has any underspend been addressed?
• Has the funder approved final reporting?
• Has the accounting code or project been closed?
• Has the board been informed of completion?

How restricted funds affect reserves

Restricted funds should not usually be counted as general reserves.

Reserves are generally funds available to support financial stability and respond to uncertainty. Restricted funds are tied to a purpose and may not be available for general use.

This distinction matters for financial sustainability.

For example, a charity may appear to have six months of cash in the bank. But if most of that cash is restricted, it may have only one month of unrestricted operating reserves.

Boards should ask for reserve reporting that separates:

• restricted funds
• unrestricted operating cash
• board-designated reserves
• funds needed for upcoming liabilities
• cash genuinely available for unexpected needs

Without this separation, the board may overestimate the organisation’s financial resilience.

How restricted funds affect decision-making

Restricted funds should be considered before the board makes financial decisions.

For example, before approving a new hire, program expansion or equipment purchase, the board should understand:

• whether funding is restricted or unrestricted
• whether the cost is allowed under the funding agreement
• whether the funding is one-off or ongoing
• whether there are reporting obligations
• whether there are hidden overhead costs
• what happens when the funding ends
• whether the organisation has enough unrestricted funds to support the decision

This helps avoid committing the organisation to costs that restricted funding cannot cover.

For broader planning, budgeting and funding support can help boards see how restricted funds, unrestricted income and future commitments fit together.

How Hopscotch can support restricted funds reporting

Restricted funds are easier to manage when the financial system is set up properly.

That means income, expenses, budgets, acquittal deadlines and reporting obligations need to be visible throughout the year.

Hopscotch helps not-for-profits improve financial reporting, grant tracking, board packs and finance processes so restricted funds are easier to understand and manage.

For charities and NFPs managing grants, donor restrictions or program-based funding, clear not-for-profit accounting support can reduce confusion and help the board make decisions with better information.

Final thoughts

Restricted funds are funds that must be used for a specific purpose. They may come from grants, donor restrictions, appeals, government funding, sponsorships or philanthropic agreements.

They are not automatically available for general operating costs, even if they are sitting in the organisation’s bank account.

For charities and not-for-profits, restricted funds need careful tracking because they affect cash flow, reporting, acquittals, reserves, governance and financial sustainability.

Boards should make sure restricted funds are clearly separated from unrestricted funds in reporting, monitored against conditions, included in cash flow discussions and supported by proper records.

If your organisation is managing restricted funding but the board cannot easily see what is available, what is committed and what needs acquittal, Hopscotch can help bring clarity to the reporting and controls that support confident governance.