Encumbered funds are monies that are intentionally set aside to pay for future obligated or planned expenses, according to the Business Dictionary. Although encumbered funds are not released until the payment for the future expenses is due, the funds cannot be used for anything other than their specified purposes, according to the State of New York's Office of the State Comptroller.
The State of New York's Office of the State Comptroller lists monthly lease agreements, monthly maintenance agreements and capital construction costs as common types of encumbered funds.
The purpose of encumbered funds is to predict cash outflow and avoid organizational overspending, according to the University of California, Riverside. Encumbered funds are written in accounting ledger books but are not included in actual funds balances because the payments have not yet been physically transferred. Once the encumbered funds are paid to a business, entity or organization, the encumbrance is reversed, and the funds are deducted from the organization's actual fund balance.
UC Riverside states that the formula for determining organizational cash outflow entails subtracting the actual funds and encumbered funds from the organization's budget. Sometimes, encumbered funds are put into a separate trust fund account that is set up specifically to hold the funds until their release date, according to Cornell University Law School.