How nonprofits can track and manage donor-restricted funds

Imagine you run an animal shelter, and a donor contributed $10,000 toward your animal rescue fund. The donor noted that she adopted her dog from your shelter and wants to help other dogs like hers find loving homes.

A few months later, the donor checks in with your team to see how you used her funds. Upon reviewing your records, you realize her donation was accidentally allocated to a building project to expand your facility’s cat shelter. How do you tell this passionate donor about the mixup?

This scenario is easy to avoid with proper nonprofit financial management and tracking. Follow along to learn how to track and manage donor-restricted funds effectively so you can stay accountable to stakeholders and keep your nonprofit’s finances organized.

1. Create clear guidelines for handling restricted funds

Start by aligning your team on how to handle donor-restricted funds. Creating a dedicated policy will get everyone on the same page and help guide staff members as they encounter restricted funds in their daily work. Your restricted fund policy should:

Define donor-restricted funds

First, ensure it’s clear exactly what donor-restricted funds are: donations given for a specific purpose, like building a new facility or supporting a specific program, or time period, such as multi-year pledges or disaster relief funding that must be used within a specified time period after the event.

Funds that are purpose- or time-restricted are usually temporarily restricted; that is, once the specified conditions are met, the funds can be released from restrictions and used freely. Funds such as endowments are typically permanently restricted, meaning the donated funds must be invested and maintained, but the interest they generate can be used to fund a donor-specified initiative or program.

Establish procedures for accepting donor-restricted funds

Let staff members know how you’d like them to document donor restrictions. You should categorize donations as restricted or unrestricted as soon as you receive them and record this information within your constituent relationship management system (CRM).

Additionally, include a statement in your donation agreements that clarifies how you will use restricted funds and assures donors you will track their contributions accordingly.

Include recording, tracking, reporting and reallocating guidelines

Develop clear processes for donor-restricted fund management. We’ll cover each of these areas in greater detail in the subsequent sections.

Once you finalize your policy, conduct a training session to ensure staff members understand the guidelines and legal requirements associated with donor-restricted funds. To promote transparency with donors, post an external-facing version of your policy on your website.

2. Record restricted and unrestricted funds separately in your accounting system

In addition to your CRM tracking, make sure your accounting system allows you to record restricted and unrestricted funds separately as you track your nonprofit’s finances. Follow these steps to get started:

1. Set up your chart of accounts thoughtfully. Your nonprofit’s chart of accounts is the foundation of your accounting system and contains a list of all the accounts your organization uses to record transactions. Every nonprofit should customize its chart of accounts to fulfill its unique reporting needs—and to account for restricted and unrestricted funds.
2. Create separate account categories. Within your chart of accounts, create separate account categories for restricted and unrestricted funds under a broader net assets category.
3. Develop individual accounts for each restricted fund project. Separating funds for different initiatives allows you to track revenue and expenses associated with those specific funds easily. For example, you may set up accounts for your capital campaign, endowment, and program funds.
4. Establish subcategories for different restriction types. Differentiate between permanently restricted, purpose-restricted, and time-restricted funds to align with donors’ specific stipulations.

The right accounting software can automate this process as much as possible. For instance, your solution may automatically categorize and allocate donor-restricted funds, produce automated compliance checks, and generate recurring reports.

3. Monitor restricted fund use

Once you’ve set up your CRM and accounting systems to record and track restricted funds, you must monitor your restricted fund use to ensure you allocate funds according to donor stipulations. Develop a budget for each restricted fund based on donors’ conditions. Then, implement the following practices:

• Designate fund managers. Assign a team member to each restricted fund category or project to ensure the associated donor-restricted funds are used appropriately. That way, you can distribute responsibilities amongst your team and receive regular updates on each initiative’s fund activity.
• Track expenditures in real time. Fund managers should pay close attention to spending to ensure all payments align with donors’ stipulations. They should also review spending reports to compare actual expenses to your budget and adjust accordingly.
• Keep detailed records. Documentation is key to staying accountable and transparent with donors. Maintain transaction records, including receipts, invoices, and proof of expenditure. Fund managers should also keep records of any communications with donors relating to fund use—including any changes to donors’ original instructions—to ensure continuous alignment with donors’ stipulations.

Inform donors of these procedures to help them feel more comfortable contributing a restricted donation to your organization and maintain their trust.

4. Maintain and share reports with donors

Nonprofit accounting is all about staying accountable to the stakeholders who make up your organization’s community. This is a key reason why reporting is essential in nonprofit financial management—especially regarding donor-restricted funds.

Provide periodic reports to donors to assure them you’re using their contributions responsibly. Tell them how you’ve spent their funds so far and include the remaining balance you have left to allocate. Communicate any changes in fund use and how you plan to handle them. For instance, if a project a donor contributed to gets delayed, let them know their funds will still go toward that initiative; you’ll just use them later than initially planned.

Within these reports, emphasize the impact donors’ contributions have on your cause. 97% of donors claim creating a positive impact is their main reason for giving, so adding impact information can satisfy donors and encourage them to contribute again in the future.

Include restricted fund information in your nonprofit’s annual financial reports and Form 990. YPTC’s nonprofit balance sheet guide explains that your balance sheet (or Statement of Financial Position) gives an overview of your organization’s restricted funding by reporting on net assets with and without donor restrictions. Additionally, adding restricted fund information to Form 990 allows you to boost transparency with stakeholders and comply with IRS regulations.

5. Make a plan for unused donor-restricted funds

While the above procedures should help you allocate donor-restricted funds appropriately, sometimes, you’ll end up with excess funds. Establish guidelines for handling these funds, including how and when you should follow up with the donors who contributed them.

Then, if appropriate, seek donor approval to reallocate funds. Work with your team to prioritize where unused funds should go and make your ask accordingly. For example, if a donor contributed to your conservation fund for a certain endangered species that is no longer endangered, you may ask whether they’d like to support your fund for another species in need.

Throughout this process, ensure transparency every step of the way. Donors implemented their restrictions for a reason, so take care to follow their stipulations as closely as possible and work out a solution that satisfies everyone involved.

Tracking and managing donor-restricted funds carefully is paramount to upholding strong relationships with the stakeholders who make your mission possible. However, it can be difficult to keep track of these funds in your accounting system if you don’t have extensive financial knowledge and experience. Consider working with a fractional CFO to help with restricted fund budgeting, policy development, and accounting system implementation, allowing you to manage your nonprofit’s finances effectively.