What Happens If You Don’t Keep Restricted Funds Separate in a Charity?

For many small charities, bookkeeping starts fairly simply. One person may keep the spreadsheet or accounting software up to date, while trustees make sure invoices, receipts and bank records are kept in order.

As the charity grows, the finances can become more complicated, particularly when grants, donations or fundraising income are given for a specific purpose.

This is where restricted funds become important. If your charity receives money that can only be used for a particular project or purpose, you need to make sure that restriction is reflected in your accounting records. Otherwise, it can become difficult to see how much money is available to spend and whether restricted income has been used correctly.

What are restricted funds in a charity?

Restricted funds are funds that can only be used for a specific purpose. The restriction may come from a grant agreement, from the terms of a donation, or from the way money was raised.

For example, your charity might receive a £12,000 grant to run a support programme for young people. That money has been provided for a particular purpose, so it cannot simply be used to cover another area of the charity's work because a different expense happens to arise.

The Charity Commission requires charities to manage and account for restricted funds in accordance with the restrictions attached to them. Separate restricted funds also need to be identifiable within the charity's accounts.

This means your bookkeeping needs to provide a clear record of how much restricted income has been received, what has been spent against it and how much remains.

What is the difference between restricted and unrestricted funds?

Unrestricted funds can generally be used by trustees wherever they are needed, provided the spending supports the charity's purposes.

Restricted funds come with conditions about how they can be used. For example, your charity may have £20,000 in the bank. Within that balance, £8,000 may be unrestricted, while £7,000 belongs to a grant-funded project and another £5,000 was raised specifically for new equipment.

Although the bank balance shows £20,000, only £8,000 may currently be available for general expenditure. Without accurate bookkeeping, it can be very easy to lose sight of that distinction.

Do restricted funds need to be kept in a separate bank account?

No, provided your bookkeeping clearly tracks the money received, the expenditure allocated to that fund and the remaining balance.

That said, keeping restricted money physically separate can make day-to-day management easier. Many business bank accounts now offer savings spaces, pots or additional accounts at no extra cost, which can be useful if your charity manages several funding streams.

There is no need to create a separate account for every restricted fund unless that genuinely helps you manage the money more clearly. What matters most is that your financial records remain accurate and that trustees can easily see how much restricted funding is still available.

Clear tracking also makes reporting much easier. If the income and expenditure relating to a restricted fund are not recorded properly as you go, you may later find yourself working back through bank statements, invoices and receipts to establish which costs relate to each fund. That takes extra time and can make mistakes much easier to miss.

What happens if restricted funds are spent on the wrong thing?

Trustees are responsible for making sure funds are used in accordance with the restriction placed on them.

If restricted money has been used incorrectly, the appropriate action will depend on the circumstances.

Where the restriction comes from a grant, the funding agreement may explain what happens if the money is spent outside the agreed purpose. The charity may need to contact the funder, correct the accounting records or, in some cases, return money.

Other types of restricted funds may require a different approach, depending on how the restriction arose.

Accurate bookkeeping is particularly valuable here because it allows trustees to identify problems much earlier. If the records clearly show the balance of each restricted fund, unusual or incorrect expenditure is easier to spot before the issue becomes more difficult to resolve.

Can you move money from one restricted fund to another?

You should not assume that money left in one restricted fund can be transferred to another project.

The original restriction still applies, even if the first project has finished or the charity has a greater need elsewhere.

For example, if a grant-funded project finishes with £2,000 remaining, the grant agreement may require the charity to return the unused balance. In other cases, the funder may agree that the money can be used for another related purpose.

The correct approach depends on the terms attached to the funding. Before using restricted money elsewhere, trustees should understand the restriction and check whether permission is required.

What if your charity has already mixed restricted and unrestricted funds together?

If your bookkeeping has not separated restricted funds properly, the first step is to establish what the records currently show.

Start by identifying grants, donations and fundraising income that carried restrictions. From there, you can review the expenditure connected with each fund and compare it with the original purpose. Grant agreements, invoices, receipts and previous reports to funders can all help when reconstructing the position.

For a charity with only one or two restricted funds, this may be relatively straightforward. Where several projects have been running alongside each other, or the records are incomplete, the process can become much more complicated.

This is one of the situations where professional bookkeeping support can be particularly useful. A charity bookkeeper can review the existing records, help identify the separate funds and put a clearer system in place for future transactions.

Why restricted funds often become more difficult as a charity grows

A bookkeeping system that worked well when the charity was small may become less suitable over time.

Perhaps the charity originally had one main source of income and relatively few transactions. Later, you may begin receiving grants from several funders, running different projects or dealing with additional reporting requirements.

At that point, the accounts need to provide more detailed information than they did before. This can happen gradually, which is why small charities sometimes reach a point where the person handling the bookkeeping suddenly finds that the job has become much more involved.

There is nothing unusual about that. The financial requirements have simply changed as the charity has developed.

Does a small charity need a professional bookkeeper?

There is no general requirement for every small charity to employ a professional bookkeeper.

Trustees do, however, have a responsibility to make sure proper accounting records are kept. Those records need to show the money coming into and leaving the charity, together with its assets and liabilities, and they need to provide enough information for the charity's accounts to be prepared.

Where restricted funds are involved, the records also need to show those funds clearly. Some charities are perfectly comfortable managing this internally, particularly while their finances remain relatively simple.

Professional support often becomes useful when grants increase, the number of restricted funds grows, or the person handling the bookkeeping no longer feels confident that the records are giving trustees a clear picture.

Getting help at that stage can make the accounts easier to manage and reduce the amount of time spent trying to untangle things later.

Need help with your charity bookkeeping?

If your charity's finances are becoming more complex, working with a specialist charity bookkeeper can make things much easier to manage.

Strive provides bookkeeping and accounting support for charities, with experience in areas such as restricted funds, grant income and charity reporting requirements.

Whether you need ongoing charity bookkeeping or help reviewing and organising the records you already have, get in touch with us to discuss the support your charity needs.