How to Handle Restricted Funds as a Nonprofit

When nonprofits receive charitable contributions, they need to be especially careful about how they spend or allocate the funds.

That's because, sometimes, these funds can come with strings attached. These are known as “restricted funds,” and it's critical for accounting team as well development team to understand the different types of restrictions and how they should be handled.

Furthermore, information and guidance regarding how to handle restricted funds should be shared with all team members who have access to the funds to prevent accidental misspending or allocation.

Understanding the Different Types of Restricted Funds

In simplest terms, a restricted fund is a contribution that has been made to a nonprofit with certain stipulations or requirements regarding how the money should be allocated or spent. There are three main types of restricted funds:

• Time-restricted funds: These are only permitted to be used during a specific time period.
• Purpose-restricted funds: These are designated for a certain purpose, such as a smaller program or project within the organization.
• Permanently restricted funds: These funds are designated to be kept in an investment account, allowing organizations to spend only the interest accrued on the initial amount. These earnings may also be restricted for time and/or purpose.
  
  
  

Why It's So Important to Avoid Mistakes

When a nonprofit accepts a donor-restricted contribution, it assumes a fiduciary responsibility to use the gift as intended. With a few different types of restricted grants to keep in mind, it can quickly become confusing for organizations to remember what each fund has been designated for and what kinds of restrictions they need to follow. This is why organizations run into so many problems with misuse of restricted funds; it's usually not intentional, but a simple lapse in judgment.

Regardless, avoiding misuse of restricted funds is critical to the long-term health and sustainability of any nonprofit and for a number of reasons.

Reputational Damage

For starters, when a nonprofit misuses a restricted fund, this can lead to major reputational damage if word gets out. Donors may no longer feel they can trust the organization to handle contributions responsibly, so they may stop making donations altogether. In some cases, funders may even have a legal basis for demanding repayment of misappropriated funds which could create further headaches.

Legal Risk

There's also an issue of legal risk. When restricted funds are misspent, organizations could be charged with fraud, breach of contract or other offenses that come with serious implications.

How to Better Manage Your Organization's Restricted Funds

The good news? There are a few simple and practical steps nonprofits can take to reduce the risk of misusing restricted funds.

1. Read Through Gift Letters Carefully

First and foremost, it's important to review any written documentation that was submitted with a grant or other contribution. Often times, these gift letters will include specific language that indicates whether a contribution is restricted in some way, as well as details on the specific purpose of the fund or time restrictions that may be in place.

2. Set Up Strong Policies and Tracking Systems

Make sure, too, that your organization has strict systems and policies in place when it comes to handling restricted funds. This includes a system for documenting restrictions, as well as policies regarding who has access to funds and their allocation.

Having a simple tracking system in place can also make all the difference here. Even just a simple spreadsheet document that tracks every fund and expense can go a long way in avoiding accidental misspending or misappropriation.

3. Make Sure Everybody Is On-Board

Of course, policies and tracking systems are only effective to the extent that everybody is aware of them and understands them. Make sure all team members who have access to funds are on the same page regarding policies and procedures, including executive directors, accounting and finance staff and all board members. Provide detailed training on navigating any tracking systems and documenting spending as needed.

4. When in Doubt, Ask for Clarification

Perhaps above all else, encourage team members with access to funds to always ask for clarification if they are in doubt about whether a fund can be used in a certain way. It's always better to be sure if there is any question or gray area.

Handle Restricted Funds with Confidence

With the right systems and policies in place, nonprofits can handle restricted funds properly and avoid compliance issues down the road.

If your organization doesn't already have the right protections in place, now is the time to meet with your accounting and finance team to make some changes.

To learn more about LGT and how we can serve you, contact us here.