The Do’s and Don’ts of Managing Donor-Restricted Funds

Thursday, December 11, 2025 by Guest Contributor

For nonprofit leaders, receiving a large donation is a moment of celebration. But when that donation comes with strings attached, it marks the beginning of a critical fiduciary responsibility.

Restricted funds are contributions that must be used for a specific purpose, timeframe, or program as defined by the donor. They’re a powerful way for donors to direct their impact. But for associations and nonprofits, they can quickly become one of the most challenging areas of financial compliance.

Handled well, restricted funds build donor trust and strengthen the long-term financial sustainability of a nonprofit. Handled poorly, they can lead to negative audit findings, reputational damage, loss of donor confidence, and even legal trouble.

In this guide, we’ll break down some essential do’s and don’ts of responsible donor-restricted-fund management so your organization can maintain compliance and honor donor intent.

DO: Define, Document, and Standardize Everything

The very first step in managing donor-restricted funds is drafting a gift agreement documenting the donor’s intent in writing. This documentation should include information about:

• Whether the gift is temporarily or permanently restricted: While leftover temporarily restricted funds may be released after a certain timeframe or after a certain purpose is fulfilled, permanently restricted funds (often taking the form of endowments) go toward an ongoing initiative, and your nonprofit cannot spend them directly. Instead, these are typically invested so that the principal funds are maintained and only the interest is used for a particular program or project.
• The specific purpose or program the funds must support: For example, you may note whether a donor-restricted gift will be used for a building campaign, a scholarship fund, or a specific community outreach project.
• Any timing requirements, reporting expectations, or measurable outcomes: Donor-restricted funds may include specific conditions related to when funds can be spent, how progress must be documented, or what outcomes must be achieved before restrictions are released. If these conditions aren’t properly tracked or documented, nonprofits risk misusing restricted funds, creating audit findings, or violating donor intent.

In contrast to donor-restricted gifts, restricted grants typically come with documentation and terms established by the grantor. Organizations then submit a proposal outlining the intended use of funds, and the resulting grant agreement ultimately defines the restrictions, reporting requirements, and conditions tied to the award.

Along with this restriction documentation, your nonprofit should have clear internal policies that outline who is authorized to accept restricted gifts, how restricted funds must be recorded and stored, what documentation must be collected, and how and when restrictions can be released once conditions are met. Standardization prevents confusion later and creates a defensible audit trail.

DO: Implement Meticulous, System-Based Tracking

Your accounting system must be able to track restricted funds separately from your operating dollars. This doesn’t always require opening a separate bank account, but your chart of accounts must clearly distinguish:

• Restricted vs. unrestricted revenue
• Expenses charged to specific restricted funds
• Remaining balances at any given time

Your charity donation processing system should also be equipped to flag and correctly code restricted gifts the moment they come in. This ensures funds are entered correctly from day one, which is far easier than untangling commingled funds months later. You can also organize restricted funds in projects or using classes in your accounting system so you can easily generate reports based on the specific grant or donation that is restricted.

DO: Communicate Proactively to Build Trust

Proper fund management is a powerful tool for stewardship. You should provide regular, transparent reports to donors who give restricted funds. These reports should:

• Show exactly how the money was spent
• Demonstrate progress toward the intended purpose
• Reference the original gift agreement or donor intent
• Include outcomes, impact metrics, or stories
• Any additional metrics outlined in the gift agreement

This transparency builds immense trust, demonstrates your financial competence, and makes future fundraising that much easier.

DON’T: Commingle Funds or Spend Before Conditions Are Met

Treating restricted funds as a flexible cash reserve is the cardinal sin of nonprofit financial management. If you use money designated for a capital project to cover this month’s payroll (even with the intent to "pay it back") or spending grant money before the required milestones are achieved, you can violate both donor intent and financial compliance standards, including specific accounting standards (ASC 958) and, in many states, the Uniform Prudent Management of Institutional Funds Act (UPMIFA).

Commingling, "borrowing," or premature spending can result in:

• Misrepresentation of your true financial position.
• Severe liability for your board members.
• Regulatory scrutiny and serious audit findings.
• Irreparable damage to donor trust.

Your organization must have strong internal controls to ensure restricted funds are never used for unrelated purposes or accessed before terms are fully satisfied. Crowded suggests using a unified banking platform to automate these controls. These tools allow you to:

• Segregate funds: Use subaccounts to keep restricted and unrestricted funds visually and operationally separate.
• Control spending: Set up restrictions so funds can only be spent on approved categories or with specific merchants.
• Monitor compliance: Track transactions in real time to ensure spending aligns strictly with grant requirements.

By partnering with Jitasa, your accountant can also keep an eye on any restricted funds and provide reports to your nonprofit staff members as often as you need them. They’ll manage the funds on behalf of your team to ensure they’re used properly.

DON’T: Rely on Manual Spreadsheets or Outdated Tools

If you’re tracking your nonprofit’s finances in a spreadsheet, you’re exposing your organization to unnecessary risk, especially when it comes to restricted funds. Common issues include:

• Formula errors
• Version control problems
• Copy-paste mistakes
• Incomplete records
• Difficulty reconciling across chapters or programs

This risk is magnified for multi-chapter organizations or nonprofits with several different locations. Tracking funds across different locations and volunteer leaders becomes nearly impossible with manual methods. Modern accounting and banking platforms are designed to automate this tracking, reducing risk and saving administrative time.

Final Thoughts

Managing donor-restricted funds is one of the core competencies of a healthy, trustworthy nonprofit. By implementing standardized policies, partnering with a trusted accounting firm, maintaining meticulous records, and communicating transparently, you honor the partnership you have with your donors. This diligence protects your organization from risk and, most importantly, channels your supporters' passion into real, measurable impact for your mission.

Jitasa’s bookkeeping and accounting services are affordable and cater to every nonprofit.

Learn More