Money inside a charity is not all the same. Some of it is bound by the people who gave it. Some is free for trustees to direct. And some has been earmarked by the trustees themselves, which looks like the first category and behaves like the second.
The difference is legal rather than administrative. Spend restricted money on the wrong thing, and you have breached a trust, whatever the accounts look like afterwards.
If financial governance is one of several things your board is working through, you can book a free clarity call.
Why money inside a charity isn’t all the same
In a business, money is money and the directors decide how it is spent. Charity law works differently. Money held by a charity belongs to its purposes rather than to the trustees, who hold it as stewards.
On top of that sits a second layer. When a donor gives for a specific purpose, that money becomes a separate pot inside your charity with its own rules. The trustees still hold it and remain responsible for it. They cannot move it around freely.
So one charity can hold money in several categories at once, and each carries different obligations.
Unrestricted funds: free, within your purposes
Unrestricted funds arrive without conditions. General donations from supporters, unrestricted grants, trading income, bank interest, and most legacies unless the will says otherwise.
Trustees can spend unrestricted funds on whatever they decide, with one condition that gets forgotten. It has to be within the charity’s stated purposes.
Unrestricted does not mean anything. It means anything within the work your charity exists to do. A charity whose objects cover supporting older people in one area can spend unrestricted funds on any activity supporting older people in that area. It cannot fund work with young people in another town, however worthwhile, because that sits outside its objects.
The boundary on unrestricted funds is your governing document, not the donor’s preference. This is the only category where trustees have genuine discretion.
Restricted funds: the three ways restrictions get created
Restricted funds arrive with conditions attached by the donor about how the money can be used. Where those conditions bind, the money becomes a separate trust inside your charity, and it can only be redirected through a formal Charity Commission process, sometimes not at all.
Restrictions arise in three ways, and only the first is obvious.
Explicit donor terms. A grant agreement stating that £20,000 funds the youth programme for a year. A legacy naming the food bank. A major donor’s letter identifying the project. Conditions in writing, and no room for argument.
Public appeals. This one surprises small charities. Run an appeal for something specific – help us buy a minibus – and every donation given in response is restricted, whether or not any donor wrote a condition. The appeal created the restriction. People gave for a minibus, and the money has to buy one.
Implied intent. The hardest of the three. Money given in response to something specific with nothing written down: a conversation, a donation made at a particular event, a reference in a bank transfer. Where the donor’s intent is reasonably clear, the money is restricted without any formal agreement.
The practical rule follows from all three. If you are unsure whether a donation is restricted, ask the donor and get the answer in writing. Clarifying a restriction when the money arrives is far easier than arguing about it five years later.
How to spot a restricted fund in practice
Restrictions show up in three places, and the people who see them first are often programme staff rather than the treasurer.
Grant agreements come first. Every one should say what the money is for, and the phrase to look for is “to be used for” or “to support” followed by an activity. Conditions about timing, reporting and unspent money are part of the restriction too.
Donor letters and emails come second. When someone writes to accompany a gift – I would like this to go towards your work with children – that letter is part of the legal record. Keep them, date them, and store them with the donation record.
Your own appeal materials come third. If your appeal says help us fund the new community centre and somebody gives £100 in response, that £100 is restricted to the community centre. Be careful what you ask for. Specific asks create specific restrictions.
All of which means restricted funds have to be tracked separately, throughout the year rather than reconstructed at the year end. Picture a charity holding three active grants: £15,000 for youth work, £8,000 for the food bank and £25,000 for a training programme. Each is its own pot; spending from one cannot come out of another, and at year end you should be able to show how each was used. Good record keeping is what makes that possible.
The Commission’s guidance on internal financial controls makes a connection worth noticing: the controls a charity needs depend on its size, how it operates and the types of funds it holds. Fund tracking is a controls question, not only an accounting one.
One thing worth clearing up. The Charities SORP requires separate accounting for fund types, not separate bank accounts. Charities often assume they need several accounts. Most need one, and a chart of accounts that works.
Boards rarely arrive at this question in the abstract. It usually surfaces when a funder asks what their money paid for and nobody can answer quickly, or when the reserves figure turns out to be far smaller than the bank balance suggested. If either sounds familiar, a free 30-minute clarity call is a reasonable place to start.
Designated funds: a plan, not a lock
Designated funds are unrestricted funds that trustees have set aside for a specific purpose. The word to notice is unrestricted. They are earmarked, not bound.
The difference from restricted funds is where the constraint comes from. Restricted funds are restricted by donors, from outside the charity. Designated funds are earmarked by trustees, from inside. And because trustees designated the money, trustees can undesignate it; at any board meeting, by minuted resolution. No Commission process and no formal procedure.
Charities designate for good reasons. It signals intent to staff, donors and the public, since setting aside £30,000 for a new vehicle is more credible than hoping to buy one. It supports planning. And it demonstrates stewardship in the trustees’ annual report.
Designated funds also affect your reserves policy, because money designated for a specific future commitment comes out of the free reserves figure. Designate heavily, and your reserves fall on paper, even though the money is still unrestricted and still yours to redirect.
Two mistakes recur. Some boards designate and believe they have locked the money away. They have not. Others see designated funds in the accounts and read them as restricted. They are not.
Picture a charity holding £60,000 unrestricted: £20,000 designated for a computer system, £15,000 for staff training over two years, £25,000 general. Lose a major funder and all £60,000 is available. The designations do not stop the trustees. They need to be undesignated at a board meeting, with the reasoning minuted.
Endowment: the fourth category
Endowment is a separate class of fund under the Charities SORP, sitting alongside unrestricted and restricted income funds rather than beneath either.
Permanent endowment is capital that cannot be spent. The charity holds it and uses the income it generates. Expendable endowment is capital trustees can spend at their discretion, within the purpose it was given for.
Most small charities never hold any, and if yours does, you will usually know, because it arrived through a legacy or a historic gift with terms attached. It matters here because endowment is often filed under restricted funds, which hides the fact that it has its own rules and its own statutory routes for releasing capital.
When an appeal raises too much or too little
Appeals rarely land exactly on target, and the two directions are governed differently.
Raise too little, so the purpose cannot be achieved, and the starting position is that the money belongs to the donors and should be offered back. The Charities Act 2022 softened this. Trustees can resolve to apply the funds to a similar purpose without contacting donors where a donor gave £120 or less across the financial year, or where the money came from a cash collection or a lottery. Beyond that, you agree steps with the Commission for contacting donors first. Above £1,000 the Commission has to consent to the resolution; at £1,000 or below the trustees’ decision takes effect straight away.
Raise too much, and the position is easier. Once the original purpose has been achieved, there is no obligation to offer the surplus back, and trustees resolve to apply it to a similar purpose, again with consent above £1,000.
One sentence at the point of asking avoids most of this. Say in the appeal what will happen if you raise more or less than you need, and the position is settled before the money arrives. The guide to choosing a fundraising platform covers how this plays out in online appeals.
When restricted funds have been misused
Charities discover this more often than the sector admits, usually by accident. Misuse sits on a spectrum, and it is worth being honest about where a situation falls.
At one end are honest mistakes. A grant agreement filed and forgotten. Donor intent never recorded. Restricted income that nobody recognised as restricted when it arrived. The charity spent the money on its own work, in good faith, from the wrong pot.
In the middle sits misconduct or mismanagement. The Charity Commission has a statutory function to identify and investigate misconduct or mismanagement in a charity’s administration, and this is where a charity has repeatedly failed to track restricted funds, or where trustees knew about a problem and did not address it.
At the far end is deliberate abuse, where money has knowingly been used for purposes it was never given for, including fraud.
What to do is much the same wherever a situation falls, and the first step is the one people skip. Establish what happened and when, and write it down. Preserve the evidence. Review how the money came to be spent wrongly, and what in your controls allowed it. Where fraud may be involved, report it to Report Fraud and take legal advice. The Commission’s guidance on protecting your charity from fraud sets out the immediate steps.
Then consider whether it meets the threshold for a serious incident report. And note the mechanism that surfaces it, whether you act or not: charities with income over £25,000 confirm on their annual return that no reportable serious incidents went unreported during the year.
If something in this section sits uncomfortably close to your own charity, the worst response is to do nothing. Speak to a charity-friendly accountant, and where the matter is significant, contact the Commission directly.
This article is general information for UK charities and not advice on any specific situation. The Commission’s Charity finances: trustee essentials (CC25) is a useful starting point for trustees. Where funds may have been misused, or where you are considering redirecting restricted money, take advice before acting.
If your board needs to get confident on financial governance, our charity governance support covers the controls and reporting that make it routine.
