Budgeting with Restricted Funds

Does your organization find it difficult to budget for restricted funds received in one year and spent in the following year?

Budgeting for a nonprofit can be challenging, especially when managing restricted funds. These funds, earmarked by donors for specific purposes or time, often require meticulous planning and accounting. One common question is how to incorporate prior year donor-restricted funds that were recorded as revenue in the previous year but will be spent in the current year as expenses, without including them as current year income in the budget.

Understanding Restricted Funds

Restricted funds are contributions given to a nonprofit with specific requirements made by the donor on how they can be used. They differ from unrestricted funds, which the organization can use for any purpose. Restricted funds are typically classified into two categories:

• Funds that must be used for a specific purpose or within a specific time frame.
• Funds that must remain intact in perpetuity, often generating income for restricted purposes.

Why Budgeting with Restricted Funds Matters

Proper budgeting for restricted funds ensures:

• Compliance: Meeting donor restrictions avoids legal and reputational risks.
• Transparency: Demonstrating responsible stewardship builds donor trust.
• Accuracy: Reflecting all available resources prevents underutilization or overspending.

Steps to Budget with Restricted Funds

1. Identify All Restricted Funds

Begin by reviewing your accounting records to identify restricted funds available for the current budget year. This includes:

• New donations and grants to be received with restrictions.
• Carryover restricted funds from prior years. These are contributions received in the prior year but not spent as of the end of the prior year.

2. Exclude Prior Year Restricted Funds from Income

While prior year restricted funds provide resources for the current year, they are not included in current year revenue for the budget since they were already recognized as income in the prior year. Instead:

• List these funds as a separate funding source in the budget narrative or supporting schedules.
• Track their use in the expense section of the budget.

3. Incorporate Prior Year Funds into Expenses

Allocate carryover funds to their specific purpose in the current year’s budget.

For example, if $25,000 in restricted funds from a prior year is designated for a youth program, include $25,000 in the youth program’s expense line item.

4. Document Fund Usage Clearly

Create a detailed report showing:

• Total restricted funds carried over.
• Specific programs or projects funded by these amounts.
• Alignment with donor restrictions.

5. Communicate the Budget Framework

Clearly explain to stakeholders (e.g., board members, finance committees) that prior year restricted funds are funding specific expenses in the current year but are not reflected as current year income. This avoids confusion and ensures transparency.  This may be new for some individuals that are not familiar with nonprofit accounting, especially those that work in the for-profit sector where revenues are matched with expenses.

Incorporating Prior Year Restricted Funds into an Operating Budget

Scenario:

Your nonprofit received a $50,000 grant in December 2024 restricted for a 2025 health initiative. The grant was recorded as 2024 revenue but remains unspent.

Budgeting Steps:

1. Identify Funds: $50,000 is available for 2025 as restricted carryover.
2. Exclude from Income: Do not include $50,000 in the 2025 income section. (It was already included in the 2024 income.)
3. Allocate in Expenses:

• Staff salaries: $20,000
• Program supplies: $15,000
• Marketing and outreach: $10,000
• Transportation: $5,000

4. Report in Budget Notes: Clearly outline that these expenses are funded by prior year restricted funds.

Tips for Effective Budgeting with Restricted Funds

1. Maintain Clear Documentation: Keep records of donor agreements and restrictions to guide budgeting decisions.
2. Use Fund Accounting: Track restricted funds separately from unrestricted funds to ensure compliance.
3. Plan for Timing Differences: Understand when funds are recorded as revenue versus when they will be spent.
4. Engage the Finance Committee: Regularly review restricted fund usage with your finance committee or board.
5. Prepare for Audits: If your organization receives an annual audit, ensure records are audit-ready by maintaining clear documentation of how restricted funds are spent.

Budgeting with restricted funds requires careful planning and attention to detail. By excluding prior year restricted funds from current year income and allocating them appropriately in expenses, your nonprofit can ensure compliance, transparency, and effective resource utilization. These practices help you honor donor intentions and advance your mission.