A charity can have £186,000 in the bank and be six weeks from not making payroll — and be doing nothing wrong. Understanding why is understanding fund accounting, which trips up more new charities than any other single thing, and which no amount of careful cashflow forecasting will save you from if the underlying records do not carry it.

The problem is that the bank balance is one number and your money is at least four different kinds. Here is what each kind is, how you tell them apart, what happens when you get it wrong, and how to work out the figure that actually tells you whether you are solvent.

The four kinds of money

  • Unrestricted funds. General money that can be spent on any of your charitable purposes, including core costs — rent, salaries, insurance, the accountant. This is the money that keeps the organisation alive, and it is usually the smallest pot.
  • Designated funds. Unrestricted money the trustees have earmarked for a plan — a vehicle replacement, a building deposit, a development project. Legally it is still unrestricted: the trustees who designated it can un-designate it by resolution at any time. It is a statement of intent, not a legal condition.
  • Restricted income funds. Money given for a specific purpose. A £20,000 grant "for the after-school club" can only be spent on the after-school club — not on rent, not on salaries elsewhere, not on keeping the lights on, even if the lights are about to go off. The restriction is imposed by whoever gave the money, and it binds the trustees.
  • Endowment funds. Capital given to be held rather than spent. Permanent endowment must be retained and only the income used; expendable endowment can be converted to income by trustee decision. Rarer in new charities, but if you have one, it is not spending money.

Where a restriction actually comes from

This is where trustees most often guess. A restriction is created by the person giving the money, in the terms on which they gave it — not by what you would prefer, and not by what you have written in a budget.

In practice it comes from one of four places: the terms and conditions attached to a grant offer; the wording of a public appeal (if you asked for money "to rebuild the roof", every pound raised is restricted to the roof); a donor's explicit written instruction; or a provision in your own governing document setting up a special fund. Note what is not on that list. A funder's interest in a particular project does not restrict a general donation. A trustee's strong feeling that money "should" go to something does not restrict it — that is designation. And a restriction cannot be created retrospectively by deciding, after the money is spent, which pot it came out of.

Get the classification right at the point money arrives, in writing, and keep the offer letter. Almost every fund accounting dispute is really a dispute about what a funder said eighteen months ago.

Worked example — the balance that lies. The charity is illustrative; the arithmetic is the arithmetic every trustee should be able to do from their own accounts.

At 31 March a small charity holds £186,400 across its accounts. Core running costs — salaries, rent, insurance, admin — are £14,600 a month. On the bank balance alone that looks like 12.8 months of cover, and the board relaxes.

The fund breakdown says otherwise:

• Restricted — £134,000: £84,000 of an unspent youth programme grant with eighteen months to run, £38,000 of a building repairs grant, and £12,000 raised through a hardship appeal.
• Designated — £22,000: earmarked by the trustees for a minibus replacement.
• Unrestricted general — £30,400.

Now take out unrestricted money that is not actually available: equipment bought from general funds with a £9,600 net book value cannot be used to pay wages.

Free reserves: £30,400 − £9,600 = £20,800. Against £14,600 a month of core costs, that is about six weeks of cover, not thirteen months. And if the youth programme grant is being spent faster than the staff costs it funds are being charged to it, the real position is worse still.

Nothing here is a scandal. It is an entirely normal, well-run small charity — which is exactly the point. The bank balance was never the number.

Why getting it wrong is serious

Spending restricted money outside its restriction is a breach of trust. That is not accountancy jargon for an error: trustees can in principle be held personally responsible for making good the misapplied funds. It is also the kind of thing that surfaces — in an independent examination, in an audit, or in a funder's own monitoring — and it lands with a regulator rather than staying an internal matter.

"We were desperate" is not a defence. Neither is "we always intended to put it back". A charity that borrows from a restricted fund to cover a payroll gap has committed the breach at the moment the money moves, regardless of what it plans to do next month. The restriction stands until the person who imposed it agrees to vary it, or the Charity Commission authorises a change.

If it has already happened

Handle it in this order, and quickly. Stop. Quantify exactly how much moved, from which fund, to what. Tell the funder before they find it in a monitoring report — funders are far more forgiving of a charity that discloses than one that is caught. Restore the money from unrestricted funds if you have them. Where the sum is significant, or the charity cannot put it back, take advice and consider whether it meets the serious incident reporting threshold. What turns an error into a governance failure is almost never the original mistake; it is the concealment.

Two powers trustees often do not know they have

Restrictions are not always immovable. Since 14 June 2023, under the Charities Act 2022 reforms, trustees have had two statutory powers over permanent endowment that previously needed the Commission's authorisation:

  • Spending a small endowment. Where the market value of a permanent endowment fund is £25,000 or less, trustees can resolve to spend it, in whole or in part, without applying to the Commission.
  • Borrowing from endowment. Trustees can borrow up to 25% of the value of a permanent endowment fund without a Commission order, provided arrangements are in place to repay it within 20 years.

Neither power touches ordinary restricted income funds. For those, the routes are the ones that have always existed: ask the funder to vary the terms in writing, or apply to the Commission. Both are slower than a phone call and far faster than a breach.

How to stay clean

  • Tag every pound as it arrives. Restricted or unrestricted, decided at the point of receipt against the offer letter, not reconstructed at year end. General small-business software is not built for this — it has no concept of a fund — so charities need fund-coded records from the first transaction. That is why a new charity's bookkeeping decision matters more than its bank choice; our post on what a treasurer's account is covers the banking side.
  • Recover core costs in every application. A restricted project should carry a fair share of the overheads it consumes — management time, rent, insurance, finance. Charge that share to the project fund and your core costs stop quietly eating the general fund. On a £60,000 project bid, a defensible 15% overhead contribution is £9,000 of core cost that no longer has to come from unrestricted money. Our funding guide covers how to present it.
  • Grow unrestricted income deliberately. Trading income, unrestricted donations, Gift Aid on those donations, and the small donations scheme are the only money that gives you resilience. Most charities put all their fundraising effort into the restricted pot because that is where the large numbers are.
  • Report by fund monthly, not annually. The accounts must analyse income, expenditure and balances by fund and show the movement on each material one — see our accounts guide and the changes coming under SORP 2026. Do it monthly and your funder reports write themselves; do it once a year and you find out in October what was true in March.

What to do this week

  1. Produce the fund breakdown behind today's bank balance. If you cannot, that is the finding — and it is the first thing to fix.
  2. Calculate free reserves properly: total funds, less restricted, less endowment, less unrestricted amounts tied up in fixed assets, less designated funds. Divide by monthly core costs. That number is your actual runway.
  3. Pull the offer letter for every restricted fund you hold and check what it actually says you may spend it on. Several will surprise you.
  4. Add an overhead line to the next application. Not as an afterthought — as a costed share of what the project will genuinely consume.
  5. Put the free reserves figure in front of the board and use it to set or revisit a reserves policy that stands up to a funder reading it.

Fund accounting sounds abstract right up until it is the reason you can or cannot pay your team this month. Getting it right from the first transaction is core to what our charity packages do — and it is the discipline that keeps trustees safe and funders confident. Talk to us.