We will all face a tough situation at some point in our lives, whether it is business or personal, but how we deal with it is critical.
Imagine receiving a bill in the mail that says you need to pay a $900 premium for auto insurance. What you’ll do initially if you are short of money? It’s unpleasant to borrow money from friends or family or use a credit card because suddenly you’re in debt.
You might be wondering how you will pay such a high premium without using a credit card or borrowing money.
Then it is time for you to fully understand, what is a Sinking Fund. You definitely need one in 2022
What is a Sinking Fund?
A sinking fund is a fund set in place by a firm or a person by setting aside revenue over time to fund a future capital expense or debt repayment.
A sinking fund is a method by which we save money over time to pay off our debts. This fund is received whenever a surplus occurs in the budget each year.
You will avoid using your emergency fund unnecessarily if you save money before using it. You also give yourself more negotiating power when it comes time to buy. Sinking funds are another term for planned expenses used by people.
What is the purpose of the Sinking Fund?
The primary goal of establishing such a fund is to reduce debt. We can maintain such a fund on a regular basis to ensure that our financial position does not suffer when a debt is due. Maintaining such a fund reduces the credit risk for the borrowers.
- A sinking fund assists us in paying its liabilities in advance.
- We will be able to pay the debt on time because it has already withdrawn funds.
- A sinking fund is also used to redeem a bond or other liability in the middle(Company).
- A sinking fund also increases the company’s goodwill by paying the debt on time, which increases investor trust and attracts more investment.
How do Sinking Funds work?
When a sinking fund is established, money is transferred into it on a regular basis by the company or by a person.
Sinking funds work as follows: Each month, you set aside money in one or more categories to be used at a later date. With a sinking fund, you save a small amount each month for a set period of time before spending it.
Where should I keep my Sinking Funds?
You can manage your sinking funds in two ways: cash or digital.
A cash sinking fund, also known as the envelope method, entails creating an envelope for each expense on your list and depositing cold hard cash into each envelope on a monthly basis.
For the sake of security and convenience, You can open a new savings account to serve as your sinking fund, or simply deposit the funds into an existing savings account.
You save a small amount each month for a set period of time before spending it. Keep a record of how much is specifically for your sinking fund, either on paper or on your computer.
If you have a separate bank account for this purpose, you may find it easier to hold your sinking fund.
How to create a sinking fund?
When you know your goals and have a timeline, creating a sinking fund is fairly simple. However, there is some introduction that must be completed before you can set up your first one. Simply follow the steps outlined below.
Step 1: Make an annual budget that includes all costs other than your monthly expenses that occur at least once a year.
Step 2: Determine how much money you want or need to spend in each category. (Tip: Look for ways to cut expenses and save money that needs for you in future.
Step 3: Create a spreadsheet to track each category’s savings goal and target date.
Step 4: Calculate how much you need to save each month in order to meet all of your goals on time. Assume it’s January 1st, and you have the goals for the year. In this scenario, you’d need to save $X per month to meet each savings goal by the deadlines:
For Example :
| Sinking Fund Category | Goal Amount | Months To Save | Amount To Save Per Month |
|---|---|---|---|
| Home Repair | 600 | 12 | $50 |
| Teak Wood Furniture | $3,000 | 15 | $200 |
| Vacation | $600 | 12 | $50 |
| Camping | $700 | 7 | $100 |
This person would pay $400 per month to four different sinking funds in this circumstance.
Step 5: Set up a monthly automatic transfer from your checking account to a high-yield savings account.
Step 6: Keep track of your monthly savings and make adjustments as needed. You can keep track of monthly progress in your spreadsheet.
Types of Sinking Fund:
Specific Purpose Sinking Fund
In the specific sinking fund,
This sinking fund is for that specific purpose and nothing else. As a result, it is known as a specific purpose sinking fund
Variable bond Sinking Fund
A callable bond sinking fund, as the name implies, is a sinking fund in which a company has a specific call price. As a result, a callable sinking fund is available when needed.
Purchase back sinking fund
When a company wants to buy back a bond, it uses a purchase back sinking fund. A bond can be purchased from bondholders at two prices: the market price and the sinking fund price.
Regular payment sinking fund
A regular payment sinking fund is used to make regular payments to the trustee and others.
Is it a good idea to invest in sinking funds?
People frequently believe that their emergency savings account is the only one that can actually save them money when it comes to their finances. If you have an emergency fund but are still having financial difficulties, it’s possible that you don’t have any sinking funds set up.
Sinking funds are used to cover unexpected expenses. They can also assist you in saying yes to more optional exciting expenses, such as concerts and vacations.
Set up your first sinking fund today to plan ahead. Whether you want to splash the cash on a much-needed vacation or for car repair in the near future, your sinking fund has you covered.
Looking for a better way to manage your money?
Check out this: How To Build Good Financial Habits? – 2022
Conclusion
So, you now understand “How and Why to Choose Sinking Fund”?
You could be an expert at building an emergency fund or sticking to a monthly budget. Adding sinking funds to your financial skill set, on the other hand, can help you better manage your money and stay focused on your financial goals.
Having a healthy savings account is beneficial for both individuals and organizations. You’ll always have enough money to pay your bills if your budget is ahead of time for significant needs.
If you don’t, you’ll have to either sell some investments or skip the expense. Consequences may be severe if the cost is high, such as in the case of upgrading your business.
