Sinking fund is a term that often appears in the world of investment and finance. However, maybe there are still many people who don’t fully understand what a sinking fund is and how to create it.
This article will discuss in full what a sinking fund is , the function of a sinking fund , and how to create the right sinking fund .
Thus, you can more easily understand and be educated about the benefits and importance of having a sinking fund as part of a personal or corporate financial strategy.
Read Also : What are Stocks? Definition, Types, Advantages, Risks and Tips
What is a sinking fund ?
A sinking fund is a fund that is set aside periodically by a company or individual to pay debts or replace assets that have reached the end of their useful life.
Sinking funds are usually used in the context of long-term investments or bonds.
The concept of a sinking fund is quite simple, namely by setting aside a certain amount of funds periodically to ensure that a debt can be paid on time.
This method is better than having to pay off the entire debt at the end of the term or having to borrow more funds to pay off the debt.
Sinking funds can also be used to extend the life of an asset, such as a building or machine. For example, if a company owns a building that is reaching the end of its life, they can use funds from a sinking fund to refurbish or rebuild the building.
One of the benefits of a sinking fund is that it can help reduce the financial risk of a company or individual. By setting aside a certain amount of funds on a regular basis, if financial problems or unforeseen expenses occur, the company or individual still has a reserve of funds to overcome these problems.
Read Also : What is Tenor?Definition, Function, Category, and Determining Tips
In the investment context, sinking funds can also increase investor confidence. Investors will have more confidence in a bond or investment if the company or related party has a sizable sinking fund to pay off their debts.
In general, sinking funds can help companies or individuals manage their finances and avoid the risk of bankruptcy. Next, we will discuss more about the function of a sinking fund and how to make it right.
The function of the Sinking Fund is as follows
Sinking funds have several important functions in the world of investment and finance. Some of these functions include:
1. Avoid Bankruptcy
Sinking funds can help companies or individuals avoid bankruptcy risk. By setting aside a certain amount of funds on a regular basis, if financial problems or unforeseen expenses occur, the company or individual still has a reserve of funds to overcome these problems.
2. Extend the Productive Age of Investment
Sinking funds can also be used to extend the productive life of an investment. For example, if a company has a machine that is reaching the end of its useful life, they can use funds from a sinking fund to upgrade or buy a new machine.
This allows the company to continue using the machine and does not have to buy a new machine outright, which can create a large financial burden.
3. Increasing Creditors
Sinking funds can increase corporate or individual creditors. Creditors will have more confidence in a bond or investment if the company or related party has a sizable sinking fund to pay off their debt.
Thus, companies or individuals can borrow funds at lower interest rates and longer terms.
Read Also : What is a Bond? Definition, Types, Advantages, and Terms
How to Make the Right Sinking Fund
Creating a sinking fund is an effective way to manage personal or company finances. The following are some steps that can be taken to create a sinking fund :
1. Setting Goals
The first step in creating a sinking fund is to determine the goals you want to achieve. The goal to be achieved can be in the form of paying debts, renewing assets, or setting up a reserve fund.
By knowing the goals to be achieved, companies or individuals can determine the amount of funds that must be set aside each month.
2. Calculating the Amount of Funds
After setting goals, the next step is to calculate the amount of funds that must be set aside each month to achieve these goals.
The amount of funds that must be set aside each month can be calculated by taking into account the amount of debt or costs that must be incurred and the time period available.
3. Determining Sinking Fund Investment
After determining the amount of funds that must be set aside each month, the next step is to determine a sinking fund investment . The selected investment must be able to generate optimal profits in order to achieve goals quickly.
Several types of investments that can be used for sinking funds include mutual funds, deposits, or bonds.
Read Also : What is Mutual Fund? Definition, Types, Benefits and How to Choose
4. Determine the Timeframe
After determining the investment, the next step is to determine the duration of the sinking fund . The term of the sinking fund can be adjusted according to the term of the debt or the life of the asset you wish to renew.
In determining the duration of a sinking fund , companies or individuals must pay attention to the availability of funds and the expected benefits.
5. Implement Discipline
The last step in creating a sinking fund is to apply discipline in setting aside funds every month. Sinking funds will only be successful if companies or individuals are able to set aside funds every month according to a predetermined amount.
Therefore, companies or individuals must be disciplined in managing finances and set aside funds every month for a sinking fund .
By having a sinking fund , companies or individuals can better manage their finances and avoid the risk of bankruptcy. Sinking funds can also increase investor confidence in a bond or investment.
In taking steps to create a sinking fund , companies or individuals must pay attention to the amount of funds set aside, the type of investment used, and the time period of the sinking fund .
Read Also : 3 ways to provide Employee Financial Welfare
If implementing these steps, companies or individuals can achieve the desired goals and avoid the risk of bankruptcy. Hopefully this article can be useful for readers in managing their finances.
Thus the discussion about sinking funds starting from their definition, function, to how to make them. After reading this article, it is hoped that your knowledge of the term sinking fund will increase and help manage your financial condition.