Four Types of Restricted Funds
Restricted funds complicate nonprofit financial management, particularly when they account for a substantial percentage of total revenue. But the greater our awareness of the complexity, the easier it is to navigate.
Nonprofit accounting treats restricted funds as distinct from unrestricted funds because they come with conditions from the donor which must be honored. From a financial management point of view, though, there are crucial distinctions based on how those conditions relate to budgeted income and expenses. From this perspective there are four separate categories of restricted funds:
Fungible. Some restricted funds are available for expenses that the nonprofit would incur whether or not the restricted funds were available. These can be for essential programs, critical overhead or fundraising. If the restricted funds were not available, unrestricted funds would be utilized, making these restricted funds interchangeable—fungible—with unrestricted funds.
Contingent. Restricted funds may cover expenses that were planned for during the fiscal year, but where the spending is contingent upon those funds being availability. These expenses—like those in the first category—have been budgeted.*
Future. Restricted funds may be received for expenses outside the current fiscal year. Income for multi-year grants is generally recorded in the year when the grant is received but some part of it will be spent in subsequent years. Funds not being spent in the current year will appear as a windfall since corresponding expenditures won’t be incurred until subsequent years.
New Work. Restricted funds can be received for work that is not in your budget. This results in both unanticipated income and unbudgeted expenses.
These differences matter in a number of different contexts:
Clarity of income goals. The budget establishes how much income needs to be raised to support the authorized spending, but not all income is necessarily available for this purpose. Restricted income that is Fungible or Contingent supports budgeted expenses, while Future and New Work restricted income does not. Setting income goals that take this distinction into account helps ensure that the funds being raised can cover budgeted expenses.
Utility of the budget. Future funds distort income and New Work pushes both income and expenses away from what was planned in the budget. While this may be good for the organization and its work, it does make the budget less useful as a marking point. In particular, staff leaders and the Board may struggle to know if variances between budgets and actuals are problematic or not. In presenting financial results, management can compensate by identifying when variances are and are not attributable to the receipt of restricted funds or when the presence of Future and New Work funds are masking variances that would otherwise be apparent.
Financial decision-making. Restricted funds can also complicate analyses of available cash. Failing to differentiate between types of restricted funds makes it harder both to assess an organization’s present condition and then to understand the implications of possible options. The best place to address this is in the Monthly Cash Flow Projection where Future income can be excluded and New Work funds can be matched with Expenses.
The challenges posed by the different types of restricted funds can all be effectively addressed, but not without an underlying appreciation that these differences do exist.
* For many organizations, the distinction between the first two categories will not be meaningful and rarely will a sharp separation be possible. Whether funds belong to one or the other will be influenced by a host of factors including the organization’s perception of and comfort with the associated risks, the importance of the work, perceptions of the likelihood of future funding, etc.