Restricted funds are given for a stated purpose — an appeal for a building, a grant for one project — and trustees cannot lawfully spend them on anything else, even to pay wages in a crisis.
Unrestricted funds can be spent on any of the charity’s purposes, including core costs, salaries and overheads.
Endowment is capital that must be retained, where often only the investment income may be spent.
Why it matters to donors: a charity can look wealthy on the balance sheet and still be unable to pay its staff, because the money is restricted. That is why reserves are normally quoted as free reserves — unrestricted funds not already tied up in buildings and equipment. See charity reserves explained.