If you're a charity treasurer, understanding the difference between restricted and unrestricted funds is essential for accurate financial management and compliance. Getting this right ensures your charity operates transparently, meets legal requirements, and maintains trust for those that donate.

In this guide, we'll break down what restricted and unrestricted funds are, why the distinction matters, and how to manage them effectively.

What Are Unrestricted Funds?

Unrestricted funds are donations or income that can be used for any purpose that supports your charity's objectives. These funds give your organisation the flexibility to allocate resources where they're needed most.

Examples of unrestricted funds include:

• General donations with no conditions attached
• Fundraising event proceeds without a specific designation
• Membership fees
• Trading income from charity shops or services
• Investment income (unless the original capital was restricted)

Unrestricted funds are vital for covering core costs like staff salaries, rent, utilities, and administrative expenses (the essential running costs that keep your charity operational).

What Are Restricted Funds?

Restricted funds are donations or grants given for a specific purpose, as defined by the donor. Your charity must use these funds only for the purpose stated, and you cannot redirect them to other activities without the donor's permission.

Examples of restricted funds include:

• A grant specifically for a youth mentoring programme
• A donation designated for purchasing medical equipment
• Funding specifically for a building renovation project
• Sponsorship for a particular event or campaign

Restricted funds often come from grant-making trusts, corporate sponsors, or individual donors who want to support a particular aspect of your work.

Why the Distinction Matters

Properly distinguishing between restricted and unrestricted funds is not just good practice; it's a legal requirement. Here's why it matters:

Legal Compliance

Charity trustees have a legal duty to use restricted funds only for their designated purpose. Misusing restricted funds can result in regulatory action from the Charity Commission and damage your charity's reputation.

Accurate Financial Reporting

Your charity's annual accounts must clearly show restricted and unrestricted funds separately. This transparency demonstrates accountability to donors, regulators, and stakeholders.

Donor Trust

When donors give money for a specific purpose, they expect it to be used as intended. Proper fund management builds trust and encourages continued support.

Strategic Planning

Understanding your fund breakdown helps you plan effectively. You might have significant restricted funds but struggle with core costs if unrestricted income is limited.

Common Challenges Charity Treasurers Face

Challenge 1: Tracking Multiple Restricted Funds

Many charities manage several restricted funds simultaneously, each with different conditions and timescales. Without proper systems, it's easy to lose track.

Solution: Use accounting software with fund accounting capabilities. Set up separate codes or categories for each restricted fund, and regularly reconcile balances against your records.

Challenge 2: Allocating Shared Costs

Some expenses benefit both restricted projects and general operations. How do you allocate costs fairly?

Solution: Develop a clear cost allocation policy. For example, if a staff member spends 60% of their time on a restricted project, allocate 60% of their salary to that fund (if the grant terms allow).

Challenge 3: Managing Timing Differences

You might receive a restricted grant before you incur the related expenses, or spend money before the grant arrives.

Solution: Monitor cash flow carefully and maintain clear records of commitments. Your accounts should show restricted funds as a liability if you've received money but haven't yet spent it on the designated purpose.

Challenge 4: Dealing with Underspends or Overspends

What happens if a restricted project costs less than expected, leaving surplus funds? Or if costs exceed the restricted funding available?

Solution: Check the grant terms. Some funders allow flexibility or permit surplus funds to be used for similar purposes. Always communicate with donors before making changes. If a project overspends, you'll need to cover the difference from unrestricted funds.

Best Practices for Managing Restricted and Unrestricted Funds

1. Document Everything

Keep clear records of donor intentions. Save correspondence, grant agreements, and donation forms that specify restrictions. When restrictions aren't explicit, seek clarification from the donor.

2. Set Up Proper Accounting Systems

Use accounting software designed for charities that allows fund accounting. Create separate nominal codes/tracing categories for each fund type and ensure all transactions are coded correctly from the start.

3. Regular Monitoring and Reporting

Review fund balances monthly. Produce reports that show income, expenditure, and remaining balances for each restricted fund. Share these with trustees regularly.

4. Train Your Team

Ensure everyone involved in financial transactions understands the importance of fund restrictions. Staff and volunteers should know to check whether funding is restricted before committing expenditure.

5. Communicate with Donors

Keep donors informed about how their restricted funds are being used. Regular updates strengthen relationships and demonstrate accountability.

6. Plan for Sustainability

While restricted funds support specific projects, don't neglect unrestricted fundraising. Core costs are just as important as project delivery, and unrestricted funds provide the flexibility you need to respond to changing circumstances.

What About Designated Funds?

There's a third category worth mentioning: designated funds. These are unrestricted funds that have been allocated for a particular purpose. Unlike restricted funds, trustees can change their minds and reallocate designated funds if circumstances change.

For example, your trustees might designate £10,000 from unrestricted reserves for future building repairs. This helps with planning but maintains flexibility.

Managing restricted and unrestricted funds doesn't have to be complicated, but it does require attention to detail and streamlined systems. As a charity treasurer, your role in maintaining this distinction protects your organisation legally, builds donor confidence, and supports effective financial planning.

Remember: when in doubt, seek clarification from donors about their intentions, consult your charity's governing document, and don't hesitate to seek professional advice from a charity bookkeeper like us here at Bluebells Bookkeeping, who understands the unique requirements of the sector.

By implementing clear processes and maintaining accurate records, you'll ensure your charity's finances are transparent, compliant, and well-managed—allowing you to focus on what really matters: delivering your charitable mission.

Need support with your charity's bookkeeping and fund management?

At Bluebells Bookkeeping, we specialise in helping charities maintain accurate, compliant financial records. Get in touch to discover how we can support your organisation.