Nonprofit organizations are often faced with tough decisions when it comes to funding and fund accounting. While most nonprofits depend on donations and grants, it’s important to explore other options that can help your organization grow. One alternative is creating restricted funds.
In this material, we will cover the true meaning of restricted contributions and what is the overall impact they can have on not-for-profit organizations. Let’s dig deeper into nonprofit accounting!
Restricted Vs Unrestricted Funds
In fund accounting, restricted funds are money that donors give to a nonprofit organization for a specific purpose. They are not available for general use and cannot be used to support the general operations of your nonprofit organization.
Restricted contributions can be provided in a variety of different ways:
A donor might leave you money in their will or trust, specifying that it must be used only for a specified purpose (e.g., cancer research).
A donor may offer charitable donations with instructions on how it should be spent (e.g., $100K for building renovations).
A local government agency may provide funding specifically earmarked for one type of project or program (e.g., police equipment).
While a permanently restricted fund is usually called a restricted one, you can also receive a temporarily restricted fund, which means that the funds must be used within a specific time range. For example, a donor may contribute money to the designated purpose of construction of a building, and any leftover funds can be placed into an unrestricted fund once the building is completed.
Unrestricted funds, on the other hand, can be used for whatever the nonprofit considers essential. These monies are critical since they can be used for “unglamorous” but necessary expenses such as overhead charges. Unrestricted grants are highly unusual and competitive.
How Restricted Funds Work
Compared to unrestricted funds, restricted funds are used for specific purposes, as specified by the donor. The restrictions can be on the use of the funds or on the time frame in which they must be spent.
If you accept the restricted fund, these restrictions are legally binding and must be honoured by your organization. You should check with your donors to see if they want their donations to be restricted before accepting their money.
You can also block the amount of money in an endowment fund, with the aim of further interest and investment returns. If the organization is focused on education, for example, the donor may specify that the endowment fund can only be used to fund scholarships, professorships, or research projects.
Endowment funds are commonly used by charities because they provide a consistent stream of income and communicate to the community that the organization is solid and intends to be there for a long time. An endowment fund is popular among donors because they provide a tax break.
How to Create a Restricted Fund
To create your own restricted fund, follow these steps:
Obtain permission from the board of directors to create a restricted fund for your organization.
Find out if there are other groups within your organization that could benefit from having their own restricted funds. For example, check if you have various committees that hold fundraisers and find out whether they would be interested to invest in this project. If so, work with them to come up with ideas for creating those funds. Make sure they understand how important it is not only to set them up but also maintain them over time – especially given the fact that the money contributed toward these funds doesn’t go into any general pot of cash; it rather remains separate from any other money raised through various sources throughout each year by your nonprofit organization or foundation (e.g., donations collected during fundraising events).
Consult with an attorney who specializes in non-profit organizations about what kinds of documents need to be created – including things like articles of incorporation, so that everything is legally sound economically speaking, before beginning operations under this new structure.
What Are the Advantages of Restricted Funds?
For nonprofits, restricted contributions can be used for specific purposes. This means that the money raised is used to support a specific program or project, and it cannot be used for general operating expenses. For example, you may want to create a new after-school program for children in your community. You can ask donors to give money specifically toward this program by setting up a restricted account with their donation and specifying how they would like their money spent.
Another advantage of restricted funds is that they allow you flexibility in how you spend them. You do not have to allocate all of your unrestricted funds before the end of the fiscal year (or quarter). Instead, you can use any remaining unrestricted dollars at any time during the year as long as they are needed by your organization’s programs or services.
Finally, restricted funds offer organizations greater flexibility because they last longer than one year—they have no expiration dates associated with them!
What Are the Disadvantages of Restricted Funds?
There are, however, some limitations to focusing all your revenues on the restricted fund method. Here are some of them:
Restricted funds can be difficult to enforce. You may not have the resources to monitor all activities that take place in your organization, and some donors may take advantage of this fact by spending their money elsewhere.
Externally restricted funds may restrict your organization’s flexibility. If you don’t have enough money in a restricted category, you might not be able to hire staff members or conduct research as needed by your nonprofit organization.
Restricted funds may make it harder for you to get a return on investment (ROI). The more restrictions there are on how and when a donor’s money can be spent, the less likely it is that you’ll see results from it—and this could lead donors away from giving again in the future!
Creating Restricted Funds can Benefit Your Organization
There are many benefits of creating restricted funds. They allow you to set aside money for a specific use, which can help streamline your funding and support the vision of your organization. You can also create a fund that will benefit a particular group or program, making it easier to see how the money is being used.
However, there are also some disadvantages to restricted funds. The first is that they often require more paperwork than unrestricted funds do, which means more time spent on record-keeping and reporting requirements. In addition, if the restrictions on the funds aren’t clearly defined in writing before they are awarded, then they may be difficult or impossible to enforce later on when things change over time—such as an unexpected shortfall in donations from some donors!
Another main disadvantage has its roots in our legal system. Organizations need clear evidence before taking action against individuals who break rules/commit crimes (such as embezzling signatures) to avoid lawsuits against themselves by making false accusations out of anger or revenge-seeking motives rather than factually based ones.
If you want to learn more about the benefits of restricted fund accounting and its related expenses, get in contact with a specialist in nonprofit accounting. Book your free consultation with Zivo!