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A sinking fund is a fund created specifically to save or set aside money to pay off a debt or a bond. A company may face an immense outlay when the time comes to pay off debts and bonds issued in the past. In this case, a sinking fund helps soften the impact of this large cost. A sinking fund is set up so that a company can contribute and add to the fund over the years leading up to the bond’s maturity.
A sinking fund is a strategic financial tool that is used to set aside money over time for a specific purpose or future obligation. It provides a structured approach to managing anticipated expenses or debt repayments. Here are some key aspects of its definition and meaning:
The sinking fund meaning also includes the fact that this investment is for a particular goal, such as buying a car, funding a vacation, or paying off a loan. It allows investors or organisations to set aside an amount in a structured way.
Gradual accumulation in a sinking fund entails steadfast saving of a predetermined sum on a regular basis over a long period of time to offset an impending expense or debt. The strategy enables the fund to increase steadily due to regular deposits and compound interest. It also provides the required capital in due time without any financial strain.
Businesses use sinking funds to repay bonds or loans. This way, when the bond or loan is due, the company has enough money. It also helps to reduce the risk of default and reassures investors that the organisation is financially stable.
Planning and budgeting can help you to determine large or recurring monthly or quarterly expenses. This approach acts as a buffer during urgent funding needs and helps to maintain a healthy cash flow among businesses.
Sinking funds ensure disciplined savings for specific needs without affecting everyday finances. They are typically included as a systematic investment option in monthly budgets and promote better money management.
People use sinking funds to achieve personal goals, and business enterprises use them to manage liabilities or capital expenditures. Some of the common personal uses include savings for weddings, home repairs, school fees, etc. For businesses, this can include finance equipment replacement and facility upgrades.
Sinking funds encourage financial organisation by breaking large expenses into manageable savings over time and reducing reliance on credit or emergency savings.
A sinking fund is accounted as a non-current asset or long term asset in a company’s balance sheet and is also often included in the list of long-term investments or other investments. Most often seen with capital intensive companies, long term debts and bonds are issued to fund the purchases of new plants and equipment.
Let’s say that Mehta Oil Ltd, a hypothetical company, issued INR 200 crores in long-term debt in the form of bonds. The bondholders were to be paid their interest amount semi-annually. Mehta Oil Ltd decided to set up a sinking fund whereby they had to contribute INR 40 crores to that fund at the end of each financial year. By the second year in, the company will have saved INR 80 crores and by the third year, INR 120 crores of the total INR 200 crores debt.
What if the company had not opted to set up a sinking fund? Mehta Oil Ltd would have had to pay out the entire INR 200 crores at the end of the 5-year bond maturity period either from their profits, cash, or their retained earnings. That would have been a major debt to pay back all at once especially if you also factor in the cost of interest paid to the bondholders over the entire 5 year period. If the prices of oil collapsed or Mehta Oil Ltd could not arrange for the required sum of money, they wouldn’t have been able to meet their debt payment which could lead to a default in payment.
Setting up the sinking fund allowed the company to pay off less in terms of interest to the bondholders as the years passed by towards maturity of the bond and also allowed less risk to the business of paying off a lump-sum amount that was huge in the long run.
Sinking funds are versatile financial tools tailored for specific purposes. Here are common types:
Used by businesses or individuals to save for repaying loans or bonds, ensuring timely and stress-free repayments. This fund helps to reduce the need for lump-sum payments at the maturity of a loan or bond.
Allocated to replace or upgrade costly assets, like machinery or vehicles, without financial strain. By contributing regularly, investors and organisations can avoid sudden large capital outflows when equipment reaches the end of its life cycle.
This fund is reserved for unexpected expenses, such as medical emergencies or urgent home repairs, and offers a financial safety net. Thus, it prevents reliance on credits during challenging situations.
Keeping aside some funds for educational costs, such as tuition or certifications, is helpful for avoiding disruptions in learning. This approach is often used by parents for their children’s future education, while young adults can apply it to grow their careers and improve the required skills.
Dedicated to building a secure financial future post-retirement, providing stability and peace of mind. It also helps investors to get a good lifestyle and covers medical or living expenses.
The formula to calculate the sinking fund amount is based on compound interest principles:
S= FV/(1+r)n−1×r
Where:
This formula helps calculate the regular contributions required to reach a specific financial goal, considering the interest earned on savings. It’s useful for individuals or businesses planning future expenses or debt repayment.
To calculate a sinking fund:
Alternatively, you can do it manually by dividing the total amount by the saving periods if there is no interest. This way, you will have consistent and systematic savings for your financial goal.
It is ideal to keep your sinking funds in recurring deposits, flexi fixed deposits or a separate savings bank account. You can also create multiple accounts and label them based on the goals, like covering education expenses or home repairs. At the same time, avoid investing this amount in mutual funds or equities since the main purpose of shrinking funds is to fulfil short to medium-term goals.
Although both options are used to set aside money, a sinking fund is goal-oriented, whereas a savings account is used for a general reserve. Here’s a quick breakdown of both of its features:
| Feature | Sinking Fund | Savings Account |
| Structure | Separate for each goal | One consolidated balance |
| Use Cases | Paying Insurance premiums, school fees, and travel | Keeping emergency reserves and surplus income |
| Interest Rate | Moderate (based on account type) | Low to moderate (standard savings rate) |
| Ideal Tool | Recurring deposit or labelled sub-account | Regular savings account or flexi FD |
Sinking funds and emergency funds work differently, but they have equal importance. One is planned, and the other is preparing for unexpected events. Here is a quick comparison of both of them:
| Feature | Sinking Fund | Emergency Fund |
| Purpose | For expected future expenses | For unforeseen events |
| Scenarios | Festival shopping, car insurance, travel | Illness or major home repairs |
| Access | Easy but used only for the goal | Instantly accessible |
| Usage Frequency | Periodically as per plan | Rare, only during emergencies |
Setting up a sinking fund is straightforward, but it fosters discipline and savings toward certain goals.
Sinking funds provide financial security and ensure that specific goals are met efficiently. It helps you to stay organised, avoid debt and protect your emergency savings. In this aspect, some of the main benefits of sinking funds are as follows:
Sinking funds help you to stay ready for known upcoming expenses without having major financial strain. This proactive approach brings peace of mind and avoids disrupting your monthly budget.
By using shrinking funds, you can avoid taking credit cards or personal loans for making big purchases. This process is helpful in protecting you from the last-minute rush, which prevents you from missing the interest rate payments for the loan.
Creating a sinking fund encourages you to make a suitable monthly budget precisely. This promotes regular saving habits by assigning a purpose to save an amount from each transaction.
Sinking funds can break down a financial goal into manageable monthly and weekly contributions. This process makes it easier to stay committed and track your progress.
With a sinking fund in place, you’re less likely to use your emergency funds for predictable costs. This helps keep your emergency fund intact during claims. Thus, it creates a clear boundary between planned and uncertain funding needs.
A sinking fund is a powerful financial tool for individuals and businesses alike. Breaking down large financial goals into smaller, periodic savings fosters discipline and reduces stress. Whether saving for personal milestones or repaying debts, sinking funds enhance financial planning and promote long-term stability.
A sinking fund in property is a reserve held by homeowners or residents. The purpose of the fund is to meet larger and possibly unexpected needs such as fixing damaged floors or fixing pipeline leaks in the house walls.
In most cases, sinking funds are not mandatory but they are a method of avoiding future financial hurdles, default or bankruptcy for any business, hence although not always mandatory, a sinking fund is highly recommended.
Savings are general-purpose funds set aside for future needs while sinking funds are specifically allocated for planned expenses, like a vacation or car repair. Sinking funds provide a structured approach to saving for targeted goals, preventing the need to dip into emergency or general savings.
No, a sinking fund is not inherently risky. It involves saving money incrementally for a specific purpose and reducing financial strain when expenses arise. The risk level depends on where the funds are held—keeping them in a low-risk account ensures safety.
A sinking fund itself is not refundable, as it represents money you set aside for a future expense. However, if the planned expense no longer applies, you can redirect the funds toward another goal or return them to your general savings.
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