Managing Restricted Funds: How to Stay in Compliance with Grant Agreements and Donor Intentions

When you receive a gift — say, for your birthday — you can use it however you want. Contributions to your nonprofit, on the other hand, likely come with strings attached.

Nonprofit accounting rules call these “strings” restricted funds, and they come in a few different varieties:

• Purpose-restricted funds (including many grants) are designated for a specific program or project.
• Time-restricted funds can only be used during a specific time period.
• Permanently restricted funds (such as endowments) are placed in an investment account and only the interest on the account can be spent.

What’s At Risk?

How you manage those restricted funds can directly impact not only your fiscal health today but also your long-term sustainability.

• Trust: Donors and sponsors may stop giving if their money isn’t used as promised.
• Grants: Funders can demand repayment, terminate grants, or refuse renewals.
• Legal risk: Misuse can be treated as breach of contract or even fraud.
• Board liability: Persistent misuse can be seen as a breach of fiduciary duty.

How Does Misuse of Restricted Funds Happen?

Misuse of restricted funds is rarely intentional. It usually happens by accident, and almost always because the organization lacks clear monitoring and tracking systems.

Scenario 1: “We needed the money now.”

A donor has contributed to construct a new building. Partway through, the project hits some snags and grinds to a halt. Meanwhile, operating costs have been climbing, and you’re worried about keeping the lights on. Rather than let those funds sit unused, you redirect the money to general operations so your nonprofit can continue to fulfill its mission.

Your good intentions don’t override donor intent or accounting rules. When a donor or grant-maker imposes restrictions, you are obligated to either:

• Use the money only for that stated purpose, or
• Ask permission to change how the funds can be used.

Using the money for something else — even something essential — can put you out of compliance and damage donor trust.

Scenario 2: “Double dipping”

Another common scenario involves double dipping.

Let’s say a donor wants their gift to defray payroll for staff members dedicated to a specific program. Around the same time, you apply for and receive a state grant that also covers payroll for that exact same program.

If you’re not careful about how you track and code expenses, you might accidentally charge the same payroll costs to both the donor-restricted funds and the state grant — which violates the terms of the grant and the donor’s restrictions.

In both scenarios, the root problem isn’t bad actors — the culprit is weak systems characterized by:

• No consistent way to tag and track restricted funds and how they’re spent.
• Lack of clarity about which expenses belong to which funding source.
• Boards, CEOs, and accounting staff not all seeing the same clear picture of restricted vs. unrestricted funds.

When organizations put even a basic tracking system in place — and make sure leadership and finance review it regularly — they dramatically reduce the risk of these accidental misuses.

7 Tips for Managing Restricted Funds

Donors, sponsors, and grantors trust your organization to do exactly what you say you will do with their money. Putting straightforward systems and checks in place can help you protect trust and strengthen long-term funding relationships.

Here are practical steps to protect donor intent and grant compliance.

1. Clarify Restrictions

Do you have written documentation for how each grant or large donation can and cannot be used? Don’t assume. Read every grant agreement and major gift letter, flagging:

• Whether funds are restricted or unrestricted
• The specific purpose
• Any timeframe for when the funds must be used

2. Establish a Policy for Managing Restricted Funds

Eliminate confusion from the start with a clear written policy for managing restricted funds. Your policy should address things like:

• How restrictions will be documented, such as in the gift agreement, sponsorship form, or notes in your fundraising system
• Who is allowed to approve the use of restricted funds
• How you will handle situations when a restriction can’t be met (for example, going back to the donor to request a change)

You can save yourself a lot of headaches by requiring donors to state their intentions clearly up front. For example, your donation or sponsorship form might include:

“Please use my gift to support [Program Name]. If the program is fully funded or discontinued, I understand my gift may be used for the organization’s general charitable purposes.”

This kind of language clarifies donor intent and gives your organization a fallback if circumstances change.

3. Put in Place a Simple but Reliable Tracking System

Your fund accounting system doesn’t have to be fancy, but it must:

• Accurately track restricted vs. unrestricted funds.
• Tie every expense back to the correct funding source.
• Show how much you have available to spend on each program and on overhead/operations.

This might be a well-structured spreadsheet for smaller organizations or sophisticated software for those with complex funding streams. The specific bells and whistles aren’t as important as being consistent in how you track restricted funds.

4. Clarify Roles and Accountability

Everyone has a role to play:

• Executive director or CEO: Sets the tone that honoring donor intent is non-negotiable and ensures that staff understand restrictions before spending.
• Accounting and finance staff: Implement the day-to-day tracking and coding of income and expenses, and flag any potential misuse or gray areas promptly.
• Board members: Provide financial oversight, ask tough questions when something seems off, and fulfill their fiduciary duty as stewards of the organization’s resources.

Financial oversight is one of the most important responsibilities of a nonprofit board, so it’s appropriate — and expected — for board members to dig into how restricted funds are being managed.

5. Communicate About the Importance of Restricted Funds

Make restricted fund activity a standing agenda item at finance and board meetings. At each meeting, do the following:

• Highlight any negative restricted fund balances.
• Call out any funds that have been sitting unspent past the expected period.
• Brief leadership on upcoming deadlines or requirements tied to grants and restricted gifts.

Keeping this information visible helps prevent surprises and reinforces a culture of compliance.

6. Address Donor Restrictions and Grant Compliance in Training

Everyone in the organization needs to understand the importance of donor intent and managing restricted funds.

• Train program, development, and operations staff on when they can and cannot charge costs to a grant or restricted gift.
• Offer orientation for new board members on key accounting concepts, emphasizing their fiduciary duty as fiscal stewards of the organization.
• Use real-life scenarios to make the concepts concrete and memorable.

7. When in Doubt, Ask Before Spending

Create a simple internal rule: If you’re not sure a cost fits the restriction, check with finance or leadership before using the funds.

Document decisions on these gray areas — even if it’s just in an email — so you have a record of why something was treated a certain way if questions come up later.

Is Your Nonprofit Fulfilling Donor Intent?

Handled well, restricted funds can deepen donor engagement and fuel your most mission-critical work. Handled casually, they can become a hidden risk that surfaces only when a donor asks hard questions or an auditor starts digging.

The good news is that staying compliant doesn’t require fancy software. It requires clarity of purpose, consistent tracking, and shared accountability between the board, executive leadership, and accounting staff. When everyone understands their role in honoring donor intent, restricted funds become a powerful tool for mission impact.

If your organization isn’t sure where to start, begin with one step: Make restricted funds a regular topic in your board and leadership discussions, and build from there. And if you have any questions, contact your CRI advisor for guidance tailored to your organization.