Sinking Fund Meaning
Sinking funds are funds designed to pay off debts that have been created and set up specifically for that purpose. A certain amount of money is set aside regularly in the account and is used only for that purpose. It is often used by corporations to deposit money for bonds and to buy back issued bonds or parts of bonds before maturity. Moreover, the fund helps convince investors that the issuer won’t default on payments.
An effective sinking fund is meant to make it easier to pay off debt and to prevent defaults by having a sufficient amount of money to pay off the debt. Despite the fact that most bonds take several years to mature, it is always more convenient and easier to be able to reduce the principal amount before the maturity date, therefore lowering credit risk.
Sinking funds are well known to many people since even school children understand how important it is to save money for something that they want to own or purchase. During the school year, a class that wants to go to the zoo at the end can create a sinking fund that will grow toward the end of the year and can be used to pay for the field trip.