Every dollar your nonprofit takes in comes with a question attached: can you prove where it went? One grant coded to the wrong fund, one restricted gift recorded as unrestricted, one board report that lands late, and the people who fund your mission start to lose confidence.
Even though nonprofits don’t operate with a profit-driven mindset, they still need a way to track finances. Unlike for-profit companies, charitable organizations use a specific method called fund accounting to track and manage their money.
It’s a bit more complex than traditional accounting, because you have to manage, disburse, and report on funds accurately, especially when they’re designated for specific projects or programs.
Get it wrong and you’re looking at revenue issues, noncompliance, and grant mismanagement. Here’s what you need to know.
What you’ll learn:
- What fund accounting is (and who uses it)
- The fund categories: with vs. without donor restrictions
- How fund accounting differs from traditional accounting
- A real nonprofit example
- How to record and release funds
- Common mistakes to avoid, plus FAQs
What is fund accounting?
Fund accounting is a system nonprofits and other mission-driven organizations use to track money according to its purpose rather than by profit. Instead of one general pool, you separate revenue into distinct “funds” so you can prove every dollar, especially restricted grants and donations, went to the right place.
There are several different types of funds or groups that you might use in nonprofit fund accounting (more on those below), and many functional reasons and benefits to using them correctly.
What types of organizations use fund accounting?
Fund accounting reaches well beyond charities. Any organization that answers to funders instead of shareholders tends to use it, including:
- 501(c)(3) nonprofits
- Private, public, and family foundations
- Churches and other faith-based organizations
- Schools, colleges, and universities
- Healthcare organizations
- Professional associations
- Government agencies
What they share is tax-exempt status and an obligation to reinvest funding into a mission rather than distribute profit. Fund accounting is how they prove it.
Why 501(c)(3) organizations need fund accounting
If you’re sitting there thinking, “Why would I have to separate funds if they’re all going to the same cause?”, the simple answer is, because they might not be. Let’s take a look at this and other reasons why fund accounting is so important:
- Donations and grants can come with specific conditions, so you’re responsible for ensuring those funds are used properly.
- It increases accountability with internal and external stakeholders, letting you show board members and donors that you’re handling money responsibly.
- It helps you organize financial resources, so you can see where you need more funding and where you have flexibility (as long as those funds are unrestricted).
By comparison, a spreadsheet with tabs for “restricted” and “unrestricted” only works right up until an auditor, a board member, or a funder asks a question it can’t answer.
Fund categories: with and without donor restrictions
Not every dollar your nonprofit receives can be spent freely. Under current accounting standards (FASB ASU 2016-14), nonprofits sort net assets into two categories on their financial statements: funds without donor restrictions and funds with donor restrictions.
You’ll might also still see the older terms, unrestricted, temporarily restricted, and permanently restricted, and many organizations still track those buckets internally.
1. Funds without donor restrictions (unrestricted funds)
Unrestricted funds cover any purpose within your nonprofit, like salaries, administrative costs, or fundraising. They tend to make up the majority of nonprofit revenue, coming from small-to-medium donations, fundraising events, membership dues, merchandise sales, or corporate giving.
Since there is no set rule as to where you can use this money to support your nonprofit mission, you have a bit more flexibility in using these funds to support operations.
This category also includes board-designated funds, money your board sets aside for a specific use. Because the board can lift that designation at any time, these funds stay without donor restrictions, even though they’re earmarked internally.
2. Funds with donor restrictions (temporarily and permanently restricted)
Restricted funds are resources a donor or grantor has designated for a specific purpose or time. To stay compliant and keep that funder’s trust, you use the money only as intended. Restricted funds typically come from grants, large-scale donations, or corporate sponsorships.
There are two types of restricted funds you might also break down:
- Time- or purpose-restricted funds (formerly “temporarily restricted”) free up once you meet a condition or a set time passes. A program grant is the classic case. Once you’ve spent it as intended, the funds are “released” and can be treated like unrestricted revenue.
- Perpetual funds (formerly “permanently restricted”) are usually endowments. You invest the principal, can’t spend it directly, and use the investment income for the donor’s stated purpose.
Why restricted vs. unrestricted matters
Every dollar has to be defensible. Get this wrong and the damage compounds. A restricted grant booked as unrestricted can make a flat year look like a six-figure surplus that never existed, and every budget-to-actual comparison after it inherits the error. Miscoding runs the other way too: money you’re free to spend, frozen because the books call it restricted.
Fund accounting vs. traditional accounting
Fund accounting is an entirely different ball game compared to regular, for-profit business accounting. Some of those key differences include:
A real-world fund accounting example
Fund accounting clicks once you see it in motion. Here’s a simple illustration, then how one nonprofit put it into practice.
A quick illustration
Say a foundation awards your nonprofit a $30,000 grant restricted to an after-school literacy program. You record the full $30,000 as revenue with donor restrictions, not money for rent or general payroll.
As the program runs and you spend $18,000 on instructors and materials, you “release” that $18,000, moving it from with-donor-restrictions to without, to show the funder’s condition was met for that portion. The remaining $12,000 stays restricted until you spend it. (See sample journal entry in the next section.)
How it works in practice: Early Childhood Alliance of Onondaga
When the Early Childhood Alliance of Onondaga (ECA) became an independent nonprofit in 2023, Executive Director Bethany Creaser had to build financial operations from scratch, including a way to track multiple grants and funding sources without letting restricted dollars get mixed up. Working with Hiline, ECA set up grant-level tracking so that each program director could see their own grant budget and spending in real time, while the organization maintained a clear, board-ready picture across all funds.
That’s fund accounting doing its job: each grant behaves like its own fund, with its own revenue, expenses, and reporting, so the team can show funders exactly how their money was used and plan confidently even when federal funding is uncertain.
The components of fund accounting
Four financial tools do the heavy lifting in nonprofit fund accounting.
- Chart of accounts — the labeling system that keeps track of every grant, donation, and expense
- Operating budget — outlines your operating expenses and expected revenue and shows what you’re looking to achieve over the planned time period (monthly, quarterly, or annually)
- Financial statements — named slightly different from for-profit businesses, your nonprofit will use a statement of financial position, a statement of activities, and a statement of cash flow
- Monthly, Quarterly, or Annual Reports — reports from donors, board members, and tax and regulatory agencies that demonstrate how you used the funds
How to record fund accounting (step by step)
To stay compliant and use funds appropriately, record each transaction against the fund it belongs to. The lifecycle looks like this:
- Set up your chart of accounts – You'll need to capture assets, liabilities, net assets, revenue, and expenses, organized to industry standards.
- Identify what funds you need – Assign every dollar received to the correct fund as it comes in.
- Record transactions properly – Clearly note the amount and purpose for each fund’s activity.
- Track your fund balance –Keep a running total of what’s been used and what remains in each fund.
- Appropriately release funds – When a restriction is met, move the funds from with-donor-restrictions to without-donor-restrictions. This is incredibly important to get right if you want to maintain compliance.
- Reconcile your accounts – At least once a month (more often is better), compare your chart of accounts with your actual bank accounts to ensure that the funds you have available match the amounts you have recorded. Resolve any discrepancies.
- Generate fund-specific reporting – These report should clearly outline each fund and meet the unique reporting requirements for grants.
Sample journal entry, releasing a restricted fund
Continuing the $30,000 literacy-grant example, once you’ve spent $18,000 as intended, you record a reclassification:
This entry reclassifies net assets to show the restriction is satisfied. No cash moves. Exact account names depend on your chart of accounts.
Common mistakes to avoid in fund accounting
Even more so than traditional accounting, fund accounting has a lot of moving parts. Because of that, the methods used to track and manage various funds are very nuanced and can cause a lot of confusion, especially as you grow and receive more funds.
To that end, there are a few common mistakes you should avoid making:
- Having too many funds and categories — Don’t overcomplicate things. Keep your funds simple, based on their overall intended use or conditions.
- Mixing funds — You need to keep restricted and unrestricted funds separate. Don’t ever keep these funds in the same account.
- Unclear documentation — Chaotic documentation leads to chaotic financial operations. Make sure every activity you record is easy to understand and tells an accurate picture of fund usage.
- Only focusing on individual funds — Don’t get lost in the weeds of individual funds. Look at the bigger picture of what those funds all add up to as they support your mission.
Worried you’ll make a costly mistake? Don’t panic – we have a solution.
Do you need fund accounting software?
As your nonprofit grows, spreadsheets start to creak, and many organizations turn to fund accounting software to keep restricted and unrestricted dollars straight. The right tool depends on your size, your funding mix, and how much reporting your funders expect.
Get a real-time look at your nonprofit financial data
But beyond just software, what you need is an entire financial system in place.
Hiline builds your fund accounting system for you around your actual funds, grants, and programs. We track and release every restricted dollar correctly and keep it in one connected place, so your numbers hold up the moment someone asks where the money went.
With your accounting needs in good hands, you can focus on you’re real goal — making a difference in the world.
When it comes to your finances, we’ll take it from here. Contact us today to get started.
What is fund accounting in simple terms?
Fund accounting is a way of organizing money by its purpose. Nonprofits separate revenue into funds so they can show donors and grantors that restricted gifts were spent exactly as intended.
Is fund accounting required for nonprofits?
U.S. nonprofits follow GAAP, which requires reporting net assets as either with or without donor restrictions. Fund accounting is how most organizations meet that requirement and stay audit-ready.
What’s the difference between restricted and unrestricted funds?
Funds without donor restrictions can be used for any mission-related purpose. Funds with donor restrictions must be used for the purpose or timeframe the donor specified.
Do small nonprofits need fund accounting?
Yes. Even with one or two grants, separating restricted from unrestricted money protects compliance and donor trust, and it’s far easier to set up early than to untangle later.
