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What is a Sinking Fund, and Why is it Required for Repaying of Debts

by Team Finance Meaning
What is a sinking fund - Use this to repay the debt

In this article, we will talk about what is a sinking fund and what its uses are. Many people get confused when they read the name “sinking fund.” The name is sinking, but actually, it is a fantastic way to save money. Even some companies use this method to save money.

There are many ways through which you can save money for your future needs or any emergency. A sinking fund is also a method that helps you to save money from your earnings. You can use it to pay your rents or debts quickly without any frustration.

A sinking fund aims to make you able to help you when you are in desperate need of money. Let’s dive into the details of the sinking fund and see how it works. TO get complete information, read the article till the end. It would be pretty helpful to you.

What is a Sinking Fund?

As we have discussed in the intro, you might be aware of what is a sinking fund. But here, we will get into the details of the sinking fund. We will explain in detail the why, what, and how of the “sinking funds.”

A sinking fund is like a saving account you use to save money from your daily or monthly expenses. It is a slow process, but it is helpful when you have been doing it for a couple of years. A sinking fund is like a safety net to your finances.

Raising a sinking fund might be of two main types. One is that you are collecting money for some considerable purchase in the future. The other type is that you are collecting money to use in an emergency.

For the first type of sinking fund, there is some proper way. Suppose you have to buy a car after 14 months and you want to start a sinking fund for it. You have to divide the car’s price by the number of months and deposit that much amount of money each month. You can easily collect the required amount of money in just 14 months.

The Purpose for Sinking Funds

The purpose of a sinking fund is to help you pay your bills and save money for a new car. You can save money for the upcoming parties or cover any expected financial stroke. Through a sinking fund, you can achieve your financial goals and keep yourself out of debts.

Now, we know the purpose of a sinking fund and its importance in our lives. Even the children realize the importance of a sinking fund. We have seen that when a child wants to buy something, he starts collecting money for it. It is also a type of sinking fund.

When a class plans to have a trip at the end of the year, the students start a sinking fund. Throughout the year, every day, the students add some money to their sinking fund account. This sinking fund helps the students to arrange their trip with complete joy.

Like the one explained above, we might see many sinking funds examples in our daily life. A family raising a sinking fund to buy a car or a luxurious flat are examples of a sinking fund. We can even raise money for small projects not to have to pay with our credit cards. With this you can raise your already dropped credit scores.

what is a sinking fund

Advantages of Sinking Funds

Though a sinking fund seems to be a childish activity, it has several advantages that even adults try. The sinking fund is popular among both adults and children. Let’s discuss some advantages of the sinking funds so you might know how beneficial it is.

Brings in Investors

Some companies also have their sinking funds, which help the company when the company goes under debts. Investors consider it risky to invest in companies that have financial problems and are under debts.

If a company has a sinking fund, it encourages the investors to invest in that company. The investors are confident as there is a sinking fund that might help the company during a crisis. The investors invest in such companies where they can quickly get their investment back.

The Possibility of Lower Interest Rates

Every investor invests in companies where he finds more protection or higher interest rates. If a company doesn’t have a reasonable financial budget or strong money protection, no investor will invest his money there.

A sinking fund provides extra protection to the investors, which attracts more investors even at low-interest rates. Companies without a sinking fund or any other financial backup have to provide the investors with hefty interest rates.

Stable Finances

The sinking fund provides a back for the company during a financial crisis. Even if the company is at its peak, it can face financial issues at any time. So a sinking fund is best to support the company in such crucial situations. It increases the credit standing of the company.

Sinking Funds vs. Savings Account

You might be thinking, why not use your savings account in time of need? There is a hairline difference between a savings account and a sinking account. The primary purpose of both accounts is identical, i.e., both are for setting some money aside for future needs.

The difference comes when it comes to the uses and goals of the accounts. A sinking account includes the money for a specific purchase or a reason. On the other hand, a savings account has money for any future needs.

Sinking Funds vs. Savings Account

Sinking Funds vs. Emergency Funds

Like the savings account, the emergency fund is also slightly different from the sinking fund. A sinking fund includes money for some specific needs that you have already planned. In contrast, the emergency fund includes money for unexpected problems that you might face at any time.

Frequently Asked Questions (FAQs)

What is a sinking fund purpose?

The primary purpose of a sinking fund is to collect money for your future needs. You can start a sinking fund to buy a car, house or to arrange a weekend holiday. Moreover, you can also start a sinking fund for your medical bills.

We can see children collecting money to buy their dream toys. That is also a type of sinking funds. Sinking funds protect your emergency funds and your credit card balance. Whenever you are in a crucial situation, the money from the sinking fund helps a lot.

What are examples of sinking funds?

We can see many sinking fund examples in our daily life. It doesn’t matter if you are a child or an adult. You can always collect money through sinking funds and later use it to fulfill your dreams. It can also help during a time of financial stroke when you are low on budget.

From a child’s life, what can we expect about why he will start a sinking fund? Probably he might have seen a toy at a friend’s house, and he also wants it. Or maybe his friends are arranging a party, and he needs money for it.

Now, what can you expect from an adult? Why would he be starting a sinking fund? We can take several examples from adults’ lives like he might need a car, a home, or maybe a foreign tour. Maybe he wants to give a surprise birthday gift to some friend or a relative.

What is a sinking fund, and how is it created?

A sinking fund is a way through which you collect money for your needs. A small amount of money is added to a sinking fund regularly. In this way, one might collect enough money so he can fulfill his desire. You can also use the money from the sinking fund in an emergency.

Before creating a sinking fund, first, you have to guess the amount of money you need to collect. Then divide the required money by the number of available days or months you have to collect this money. Now you got the answer. Add money regularly to your sinking fund.

What is a sinking fund in strata?

A sinking fund in strata contains the money you need for your apartment’s expenses and expenditure. With this money, you can repair your property or do maintenance work on your building. Your housing society collects this sinking fund from you to invest in your house in the future.

Final Thoughts

The above article was all about what is a sinking fund, its advantages, and examples. We discussed the difference between the sinking fund, the emergency fund, and the saving account. We tried to highlight the importance of a sinking fund in every part of life.

In the end, we would recommend you should instantly create a sinking account and start saving money for future needs. There are several advantages of the sinking fund but no drawbacks. Though it takes time, it is not a drawback if you are not rich enough to make an instant purchase.

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