Have restricted funds disappeared?

If I had to pick one area where nonprofits most often go astray, it would be mishandling their restricted funds.

To put it bluntly: they spend their restricted funds on things that they should not be spending them on.

The organizations that do this are of two types: those that knowingly misuse their restricted funds, and those that don’t realize what they are doing.

Those that knowingly misspend their restricted funds, in terms of the good, the bad, and the ugly, are in the ugly category.  They might justify this when faced with a cash flow emergency.  If the choice, for example, is to let funds restricted for the after school program to sit in the bank while the roof leaks, or dip into the money to fix the roof, I understand the pressure the executive director feels to take the money and fix the roof.  Nevertheless, there might have been some better options (write me for some ideas).

Those that are unaware that they are misspending their restricted funds raise some interesting questions.  Why don’t they realize they are misusing their funds?  Are they not sufficiently financially astute to recognize the situation, or are their internal financial reports unclear making it difficult to spot the problem?

More often than not, I find that the problem is inadequate financial reporting.  Nonprofit managements and boards everywhere are receiving inferior internally generated financial reports that make it difficult if not impossible for them to fully discharge their fiduciary responsibilities.

Managing a nonprofit organization with inadequate financial reports is like driving a car with a coat of paint on the windshield: you can’t see where you are going!

Interestingly, this problem of misspending restricted funds can sometimes be spotted just by looking at the balance sheet.  Here is a very simple example.

Imagine an organization that has the following two lines on its balance sheet (this example is taken from a real organization’s 990):

Total assets                             $60k

Restricted net assets             $85k

According to their balance sheet, this organization should have $85k of restricted assets.  However, they only have $60k of assets.  What happened to the other $25k?  Barring an accounting irregularity, the money is gone.  Maybe they took the $25k to fix the roof.

Moral of the story:  if an organization accepts a pledge, donation, or a grant, etc., with restrictions attached to it, the organization is obligated to honor those restrictions.  If their financial reporting is such that they cannot tell whether they have dipped into this money in violation of a restriction, then they need to get professional help to fix the situation.

Comments welcome.

Eric Fraint, President and Founder
Your Part-Time Controller, LLC