Fund accounting for nonprofits starts with an uncomfortable sentence: the money in the bank is not all yours to spend. Dana found that out on a Tuesday in August, with $40,000 in the operating account and a hiring decision she could not safely afford.
Dana is a composite. I built her from a pattern that turns up again and again in small nonprofit books, and I invented her numbers so the arithmetic stays easy to follow. Her organization is a youth literacy nonprofit in Central Texas. It has three staff, a volunteer treasurer who is a retired engineer, roughly $22,000 going out the door in a normal month, one checking account at a credit union, and a QuickBooks Online file that a board member's nephew set up years ago on the default small-business chart of accounts.
Nothing in that setup is unusual, and nothing in it is negligent. It simply answers a different question than the one a nonprofit board needs answered.
The Tuesday the bank balance lied
The week before, the board had met. The treasurer pulled up the bank balance on his phone, saw forty thousand dollars, and asked why the organization was still debating whether it could afford a second reading coach. It was a fair question from a careful person. The motion to hire passed, and the offer went out that Friday.
On Tuesday, Dana sat down to fill out an interim report for the family foundation that funds the after-school reading lab. One line on the form asked for the unspent balance of the grant. She did not know it. QuickBooks could tell her how much the organization had spent on books and training, but it had no idea which dollars had paid for them.
So she did it by hand, on a legal pad, working backward from the bank balance:
- Cash in the operating account: $40,000
- Reading lab grant, unspent: $18,000. The foundation had given $30,000 for the lab, and $12,000 had gone to curriculum and tutor training.
- Van campaign gifts: $9,500, raised through a spring appeal to buy a used passenger van.
- County contract advance: $5,000, paid up front on a cost-reimbursement contract and not yet earned.
- Payroll taxes withheld and a credit card statement due: $3,200
- What was left: $4,300
Against $22,000 of monthly expenses, $4,300 is about six days of operating cash. The board had voted to add a salary on the strength of a number that was nearly 90 percent spoken for.
Nobody had lied to them. The bank balance was accurate. It was just answering ‘how much cash exists’ when the board had asked ‘how much cash is ours to direct.’ Those are different questions, and the entire discipline of fund accounting exists to keep them apart.
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What is a fund when a nonprofit keeps all its money in one bank account?
A fund is a labeled claim on a pool of money, not a separate pile of money. A nonprofit can hold five funds in one checking account the same way one refrigerator can hold groceries belonging to five roommates. The bank tracks the total. The ledger tracks who each dollar is promised to. Fund accounting is the practice of keeping those labels accurate every month.
The accounting standards give those labels official names. Since FASB's ASU 2016-14 took effect for fiscal years beginning after December 15, 2017, a nonprofit's net assets fall into two classes: net assets without donor restrictions and net assets with donor restrictions. Many board members still use the older three-part vocabulary of unrestricted, temporarily restricted and permanently restricted. The older words are fine in conversation. The two-class version is what appears on audited statements and on the Form 990.
Three things about restrictions surprised Dana, and they surprise most executive directors.
Only a donor can restrict a gift
A restriction comes from outside the organization: a donor, a grantor or the law. The board cannot create one. When a board votes to set aside money for a rainy-day reserve, that money is board-designated, and it stays inside net assets without donor restrictions because the same board can vote to release it next month. I wrote about that distinction at length in the piece on why most designated funds are not actually restricted, and the logic is identical for a secular nonprofit.
The appeal letter can create the restriction
Dana's van donors mostly wrote nothing on their checks. It did not matter. The spring appeal asked people to help buy a van, so the gifts that came in response are restricted to buying a van. The wording of the ask travels with the money. This is why the development director and the bookkeeper need to talk before an appeal goes out, not after the deposits land.
Restrictions come in three kinds
- Purpose restrictions limit what the money can be spent on, like the reading lab grant.
- Time restrictions limit when it can be spent, like a pledge for next fiscal year's operations.
- Perpetual restrictions mean the original gift is never spent, as with an endowment. In Texas, endowment spending is governed by Chapter 163 of the Property Code, the state's version of UPMIFA.
Two items on the legal pad were not funds at all. The withheld payroll taxes and the credit card bill are ordinary liabilities. The county advance is one too. Under ASU 2018-08, money received on a cost-reimbursement contract is a conditional contribution: the organization has to incur qualifying expenses first, and the county can take the money back if it does not. Until then the cash is a refundable advance. Liabilities come off the top before anyone starts dividing net assets into funds.
The scale of restricted giving is not small. According to Giving USA, Americans gave $592.50 billion to charity in 2024, and foundations accounted for $109.81 billion of it. Foundation grants are the dollars most likely to arrive with a stated purpose, a budget and a report form. A nonprofit that grows will almost certainly grow into restricted money.
Why can't nonprofits borrow from a restricted fund and pay it back later?
This was the question Dana actually wanted answered that Tuesday. The reading lab money was sitting right there. The county reimbursement would arrive in September. Why not cover the new coach's first paychecks from the grant balance and make it whole in a few weeks?
Spending restricted money on something else, even briefly, breaks the terms the organization agreed to when it accepted the gift. The donor gave for one purpose and the nonprofit used the money for another. If the expected cash arrives late or not at all, the organization has spent money it cannot replace, and the grant report will show a balance the bank account cannot back up.
The consequences run from awkward to serious. A foundation can ask for its money back or decline to renew. An auditor will flag it. Board members carry a fiduciary duty over charitable assets, and state attorneys general have oversight of them. Where the line sits for a specific gift is a legal question, so talk to your CPA or attorney before moving restricted money, not after.
What makes this dangerous in a small organization is that the borrowing is invisible. In a single-fund ledger, the checking account stays positive the whole time. Payroll clears. Nothing bounces. The only place the problem shows is in a report most small nonprofits never run: the balance for net assets without donor restrictions goes negative while total cash stays healthy. That negative number is the unrestricted side of the house living on restricted money.
Dana did the less exciting thing. She called the foundation's program officer, explained the timing, and asked a specific question: would a second reading coach who works in the after-school lab count as a cost of the lab? The answer was yes, and she asked for it in an email. The coach's lab hours could be charged to the grant because they were the grant's purpose. She also pushed the start date back two weeks and asked the county whether she could invoice monthly instead of quarterly.
None of that required new money. It required knowing which bucket each dollar sat in, which she had only just learned.
How should fund accounting be set up in the ledger so the math does itself?
The legal pad worked once. It will not work every month, and it should not live in the executive director's head. Here is the structure we rebuilt Dana's file around, and it is what I would look for in any small nonprofit's books.
One chart of accounts, one fund label on every transaction
The instinct is to create a separate set of accounts for each fund, or to open a bank account for every grant. Both create more work and more places for errors. The better design is a single chart of accounts with a second dimension that tags every line to a fund.
In QuickBooks Online that dimension is Classes, which are available only in the Plus and Advanced plans. Dana's file got four: General Operating, Reading Lab Grant, Van Campaign and County Contract. Purpose-built systems such as Aplos, MIP, Sage Intacct and Blackbaud Financial Edge NXT have a true fund segment that forces each fund to balance on its own. QuickBooks does not. The class mechanics are the same ones I walked through for setting up classes and fund tracking in QuickBooks Online, with one warning worth repeating. When I open a nonprofit's file for the first time, I run the Balance Sheet by Class and look for a column headed ‘Not specified.’ Any balance there means transactions were entered without a fund, and every fund total on the page is suspect.
Net asset accounts that match the standards
The equity section of a small-business chart has owner's equity and retained earnings. A nonprofit's should read like this instead:
- Net assets without donor restrictions, undesignated
- Net assets without donor restrictions, board-designated
- Net assets with donor restrictions, purpose
- Net assets with donor restrictions, time
- Net assets with donor restrictions, perpetual
QuickBooks closes each year into a single retained earnings account, so someone has to post a year-end journal entry that splits that balance back into the right net asset accounts. If nobody has done that for three years, the fund balances on the reports are wrong even when every transaction was classed correctly.
A monthly release entry
When restricted money is spent on its purpose, the restriction is satisfied. The books record that as net assets released from restrictions, which moves the amount out of the restricted class and into the unrestricted class where the expense sits. Dana's file had never recorded a release. That is why she could not answer the foundation's question: the $12,000 already spent on curriculum and training had never been matched against the $30,000 grant. A release entry at each month-end close keeps the remaining balance of every restricted fund current.
Grant rules that changed recently
If any of your funding is federal, including federal money passed through a county or state agency, the Uniform Guidance at 2 CFR 200 was revised in 2024. Two changes matter to small organizations. The de minimis indirect cost rate rose from 10 percent to 15 percent of modified total direct costs, which means more of a federal award can legitimately cover rent, insurance and administration. The single audit threshold rose from $750,000 to $1,000,000 in federal expenditures for fiscal years beginning on or after October 1, 2024. The Uniform Guidance does not generally require a separate bank account for federal money. It does require that you can trace the receipt and spending of each award, which is exactly what a fund label does.
What does a board report look like once fund accounting is working?
It is one page, and the number at the bottom is the one the board should argue about.
The report is a statement of financial position with a column for each fund. Dana's first one showed $40,000 of cash across the top, $8,200 of liabilities, $27,500 of net assets with donor restrictions split between the reading lab and the van, and $4,300 of net assets without donor restrictions. Under that, a single line: cash available for general operations, $4,300, about six days.
That line is the small-organization version of something larger nonprofits are required to publish. ASU 2016-14 added a liquidity and availability disclosure to audited statements, which reports the financial assets available to meet general expenditures within one year. The IRS asks a related question. Part X of the full Form 990 separates net assets without donor restrictions on line 27 from net assets with donor restrictions on line 28. Organizations small enough for the 990-N, which the IRS limits to those with gross receipts normally $50,000 or less, never report that split to anyone. Neither do churches, which are exempt from filing a 990 at all. The donor's restriction binds them all the same.
A column-per-fund layout is the same idea behind a fund balance report, and if your organization is a congregation, the companion piece on how fund accounting works for churches covers benevolence, missions and building funds specifically. If you are weighing whether your current books can produce this page at all, the comparison of nonprofit bookkeeping and standard books lays out what has to be different.
Three board meetings later, the treasurer no longer opens with the bank balance. He opens with days of unrestricted cash, which had climbed to nineteen after the county moved to monthly invoicing. The reading coach started in September, charged to the grant for her lab hours, with the foundation's email in the file. The van campaign is $2,500 short of its goal, and everyone in the room knows that the $9,500 already raised is not available for anything else.
At Turnkey CFO we keep the books. We do not prepare, review or sign the Form 990. That is your CPA's work, and a ledger built this way is what lets them do it without rebuilding your year first.
Dana's organization did not get any richer between August and November. It got an honest number, and the board started making decisions against it.
Fund accounting questions nonprofits ask
Does a nonprofit need a separate bank account for each fund?
No. Funds are tracked in the ledger, not at the bank. One operating account can hold many funds as long as every transaction carries a fund label and the books can report each fund's balance. Open a separate account only when a specific grant agreement or donor requires it, or when an endowment is invested separately.
Is board-designated money restricted?
No. Only a donor, a grantor or the law can restrict money. A board-designated reserve is an internal decision that the board can reverse, so it is reported within net assets without donor restrictions. It is still worth showing on its own line so the board can see what it has set aside.
Can a small nonprofit do fund accounting in QuickBooks Online?
Yes, using Classes in the Plus or Advanced plan, with one class per fund and nonprofit net asset accounts in place of owner's equity. QuickBooks will not force each fund to balance, so someone has to review the Balance Sheet by Class each month and post year-end entries to split retained earnings into the correct net asset accounts.
What happens if we already spent restricted money on general expenses?
Measure it first: rebuild each restricted fund's balance and compare the total to available cash. Then tell the board, and talk to your CPA or attorney about the options, which can include restoring the fund from unrestricted income or asking the donor to modify the restriction in writing. Do not leave it unrecorded.
Do nonprofits that only file the 990-N still need fund accounting?
If the organization has ever accepted a gift or grant for a stated purpose, yes. The filing threshold decides what the IRS sees, not what the donor is owed. A two-fund ledger, general and one restricted, is enough to start.
Frequently asked questions
Does a nonprofit need a separate bank account for each fund?
No. Funds are tracked in the ledger, not at the bank. One operating account can hold many funds as long as every transaction carries a fund label and the books can report each fund's balance. Open a separate account only when a grant agreement or donor requires it, or when an endowment is invested separately.
Is board-designated money restricted?
No. Only a donor, a grantor or the law can restrict money. A board-designated reserve is an internal decision the board can reverse, so it is reported within net assets without donor restrictions. It is still worth showing on its own line so the board can see what it has set aside.
Can a small nonprofit do fund accounting in QuickBooks Online?
Yes, using Classes in the Plus or Advanced plan, with one class per fund and nonprofit net asset accounts in place of owner's equity. QuickBooks will not force each fund to balance, so someone has to review the Balance Sheet by Class each month and post year-end entries to split retained earnings into the correct net asset accounts.
What happens if we already spent restricted money on general expenses?
Measure it first: rebuild each restricted fund's balance and compare the total to available cash. Then tell the board, and talk to your CPA or attorney about the options, which can include restoring the fund from unrestricted income or asking the donor to modify the restriction in writing. Do not leave it unrecorded.
Do nonprofits that only file the 990-N still need fund accounting?
If the organization has ever accepted a gift or grant for a stated purpose, yes. The filing threshold decides what the IRS sees, not what the donor is owed. A two-fund ledger, general and one restricted, is enough to start.