Nonprofit Fund Accounting Explained for Executive Directors

A common moment, in round illustrative numbers: the bank balance shows $150,000, payroll runs on Friday, and the bookkeeper mentions that $120,000 of it belongs to the mentoring grant. That gap between the bank balance and the money you can spend is why nonprofit fund accounting exists.

We see it constantly at the Center for Nonprofit Coaching: in a small nonprofit the executive director is often the finance team as well as the HR department. The journal entries stay with your bookkeeper. Your part is knowing which dollars carry a donor’s conditions and how much is left. This guide covers that part of managing nonprofit finances.

How Does Nonprofit Fund Accounting Work?

Nonprofit fund accounting records every gift with any purpose or time limit the donor set, keeps a running balance for each restriction, and rolls those balances into two classes on the financial statements. A “fund” is a label in the books for a grant, program or restriction, and it does not need its own bank account.

The rules come from the Financial Accounting Standards Board, which sets the accounting standards nonprofits follow. In its rules as amended by Accounting Standards Update 2016-14, restrictions generally apply to net assets as a whole, and cash received with a donor restriction can be reported together with cash without donor restrictions. Your bank balance mixes both kinds of money. Only the books can separate them.

What Types of Funds Does a Nonprofit Track?

A nonprofit reports two classes of net assets, and its books can track several types of funds inside each. Without donor restrictions, money is general operating money or money the board has set aside. With donor restrictions, it is tied to a purpose or a time period, or must be kept permanently.

The standard requires only the two classes. How you group funds inside them is your organization’s choice.

Board-designated money is the type leaders misread most easily. A board can earmark unrestricted money for a reserve or a future project, and the Journal of Accountancy, published by the American Institute of CPAs, notes that the board can also undesignate it at its discretion.

The IRS agrees: the Form 990 instructions put all funds without donor-imposed restrictions on Part X, line 27, regardless of any board designations.

Where Do Restricted Funds Show on Statements?

Restricted funds show up in two statements and one note. The statement of financial position reports net assets in each class and in total. The statement of activities reports the change in each class, including the money released from restrictions. A liquidity note describes the financial assets available for general expenditures within a year.

On the statement of financial position, the net assets section shows one line per class and a total. For organizations that follow these rules, the same two figures appear on the public Form 990, Part X, lines 27 and 28.

The statement of activities is where restricted money changes hands. Under Accounting Standards Update 2016-14, expenses are reported in the column for net assets without donor restrictions. When you spend on a restricted purpose, or a time restriction runs out, a line called “net assets released from restrictions” moves that amount from the restricted column to the unrestricted one. If another funder, such as a government contract, also pays for the same cost, ask your accountant which source the cost counts against.

Timing can make a steady year look uneven. A restricted gift recorded in one year and spent over the next two makes the restricted column rise, then fall, while the program runs at the same pace. Our guide to reading the statement of activities walks through the columns.

The same update requires year-end statements prepared under generally accepted accounting principles to describe, in words and numbers, the financial assets available to meet cash needs for general expenditures within one year.

What Decisions Does Fund Accounting Force?

Fund accounting forces three decisions on the executive director: whether a restricted gift can pay for a given cost, what to promise staff and funders while money is still restricted, and how much unrestricted money the organization holds. Your bookkeeper supplies the numbers. The commitments are yours.

Can restricted money cover payroll? For staff whose work is the restricted purpose, often yes, if the grant terms allow salaries. Under the standard, a restriction is met to the extent you spend on its purpose, so a program coordinator’s salary charged to that program’s grant is the grant doing its job. Payroll for other work needs another source, such as unrestricted money or a grant that covers that work. Confirm the split with your accountant.

An illustrative case in round numbers: an organization with a $350,000 budget holds $150,000 in the bank. Its accountant confirms that $120,000 of that cash is the unspent part of a foundation grant restricted to the mentoring program, which leaves about $30,000 for general spending. Monthly payroll is $22,000, of which $8,000 is mentoring staff the grant covers. The other $14,000, plus rent and every other bill, has to come from that $30,000. That is about two months of payroll alone. The bank balance suggested almost seven.

An illustrative coaching exchange: the same executive director wants a second mentor before the grant ends. The coach asks what the board would need to see, and the answer becomes a request for a six-month forecast with grant and unrestricted money on separate lines.

Before you sign a restricted grant, ask what the work will cost beyond what the grant pays, and plan that gap when you are building restricted grants into the budget.

Using restricted money for something else, even for a week, is a question for your accountant before it happens, and often a conversation with the donor.

The bank balance tells you how much money the organization holds. Fund accounting tells you how much of it is still yours to decide.

Which Fund Accounting Basics Do You Need?

A small nonprofit needs four fund accounting basics in place, and your bookkeeper or accountant decides how to run them: the terms of each restricted gift on file, a report of each restricted balance, releases that match spending, and restricted balances checked against funder reports and the bank. Your part is asking whether they happen.

1. Restrictions on file. Ask: where do we keep the award letter or donor note that sets the terms of each restricted gift?
2. A balance for each restricted gift. Ask: can you print every restricted balance on one page, gift by gift?
3. Releases that match spending. Ask: when were releases from restriction last recorded, and do they match what we spent?
4. Balances checked. Ask: do restricted balances match our funder reports, and if every restricted grant were spent as promised tomorrow, would the cash be there?

Setup and software choices are your bookkeeper’s or accountant’s call. The written rules around it belong in your financial policies and internal controls. If your board has set money aside, keep the minutes that created each designation, because statements under the 2016 rules disclose the amounts and purposes of board designations. To see restricted grants as their own line, look at an annotated sample budget.

These habits are part of the financial literacy an executive director needs. Technical work on the books, such as restructuring a chart of accounts, is a job for an accountant, and the Center for Nonprofit Coaching says so during matching. A coach works on the leader’s side: the decisions and the conversations with funders and the board. That is the focus of our coaching for executive directors carrying the finances.

What Can You Do This Month?

This month, ask your bookkeeper for a one-page report of restricted balances: each restricted gift, what is left, its purpose and its end date. Set it beside your bank balance and the bills already due, and ask your accountant how much is available for general spending. That answer is your starting point before any new promise.

Coaching gives you a thinking partner for the funder and board conversations that follow. Volunteer coaches donate their time, which keeps fees 85%+ below market rate. Six sessions cost $300, $400 or $600 for organizations with operating expenses under $250,000, under $500,000 or over $500,000. Apply for coaching.

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