Academic research is funded through a variety of sources each of which have distinct pros and cons. It's important to understand these, as the funding type determines what it can be spent on and when, and what risks are associated with using it. Many basic biomedical researchers assume all funding is structured like NIH grants are.  Such assumptions can cause issues ranging from simple to administrative confusion, to slowdowns in research progress, to, in extreme cases, having to pay back funds already spent.

While universities vary in their exact terminologies and classification methodologies, much is shared. As with anything funding-related, check with your research administrator or financial analyst to clarify how things are set up at your institution.

Sponsored versus Non-Sponsored

The primary categorical distinction between funding types is sponsored and non-sponsored funds. Put simplistically, sponsored funds are funds that come with specific conditions attached to them. They may require dedicated effort from the PI, have binding start and end dates, be directed toward a defined line of inquiry, set of objectives, or deliverable, and/or have precise reporting requirements. The exact conditions vary by fund. By contrast, non-sponsored fund requirements are more generalized. A small subset may be “unrestricted” but most have some sort of requirements or limitations attached to their use.

Federal and state grants (NIH, NSF, CIRM, DoD) are nearly always sponsored funds, as are grants from major foundations and nonprofits (American Heart Association, Gates Foundation). Contract funds from industry (Pfizer, Merck) are also usually sponsored. Startup funds, endowments, patent royalties, and private gifts are usually non-sponsored.

Sponsored and non-sponsored funds differ in what expenditure categories can be charged to them. Sponsored funds normally have a clearly defined scope of work, noting specific aims, milestones, or deliverables. Industry contracts often define deliverables. Sponsored funds can only be spent on things that further the scope of work. Sponsored funds can also require a level of effort or commitment, usually defined as %FTE or calendar months effort, for the PI and other key personnel. This information is specified directly in the notice of award or contract, which defines the budget. In the budget, specific dollar amounts are designated for personnel costs (salary and benefits/fringe), capital equipment, travel, animal expenditures, materials and supplies, facilities and administrative rates, indirect costs, etc.  Some sponsored funds have flexibility built into these requirements (they allow rebudgeting between categories), others don't.

Sponsored projects also specify when funds will be released. Some are funded upfront (you receive a lump sum of money to spend down) while others follow a cost-reimbursement model (you track spending on the project and are reimbursed via invoice to a certain level). State and federal grants are usually funded upfront at the start of the grant year, assuming receipt of a progress report covering the previous year. Occasionally funds are released only after specific milestones are met or deliverables received. Subawards and Industry Contracts typically follow the cost-reimbursement model. Understanding what triggers release of the funds is key, as if you default on a requirement of a cost reimbursed fund, you are already out the money. This means you will have to spend unrestricted funds to cover costs already incurred. 

EXAMPLE. You are funded via an industry contact to complete a project with 2 milestones. You estimate it will cost you $100,000 to complete milestone 1, and $125,000 to complete milestone 2. The contract is set up as a cost reimbursement. Your university is to invoice the company for project-related costs up to $100,000 after you submit proof of completion of milestone 1, and then the remaining $125,000 after completing milestone 2. To facilitate tracking, the university sets up a fund for you to charge project costs to and creates a budget set to $225,000. You spend $180,000, but are only able to complete milestone 1. You decide to abandon the project, as it isn't working out. The company only has to reimburse you $100,000, as you only completed 1 milestone. You now have to come up with $80,000 of unrestricted funds to cover the outstanding balance you incurred on this project. 

Non-sponsored funds will have some constraints, but they are generally much less strict than sponsored. Example constraints may be "to fund research or educational activities of PI" or " for graduate student tuition". Because of this, many PIs save (hoard?) non-sponsored funds as a sort of rainy day fund, to act as a reserve if an expected fund doesn't come through. 

It must be kept in mind that every fund is unique. Fund management best practice is to examine documentation for each fund as it comes in and note requirements, restrictions, budgets, and report due dates. Coordinate with your research/finance administrator on any unusual requirements. This habit will save time, stress, embarrassment, and make sure funds are used appropriately.