What are Sinking Fund?
- 8th September 2025
- 03:00:00 PM
- 8 min read
Are you planning to gather a huge amount of funds to pay off debts or plan for a dream vacation? Then, sinking funds can help you out in this situation. Although sinking funds might sound unfamiliar, these funds can help you prepare funds without touching your emergency savings.
This blog provides a simple guide on what are sinking funds with examples, how to calculate them, their benefits, and other crucial information.
Sinking Funds Meaning
Sinking funds allow you to create a fund for big expenses without taking a loan or breaking your emergency funds. These funds enable you to slowly set funds aside for a specific purpose. This can be buying a new asset, renovating a home, or even paying off debts.
Both individuals and corporations can use sinking funds to gather a huge corpus for a specific purpose. Corporations use these funds for different purposes, like settling liabilities, repaying bonds and any other reasons.
Any corporation can create sinking funds for bonds, preferred stocks, loans, debentures, or other debt with a maturity date.
Calculation of Sinking Funds With Example
Understanding the calculation of a sinking fund is necessary to determine the amount you must contribute regularly to meet a target amount in the future.
The formula for calculating the periodic contribution of sinking funds is:
Periodic Contribution = FV / [((1 + r)^n – 1) / r]
Below are the key metrics of the formula:
-
Future Value (FV)
FV is the corpus you want to create at the end of the period. For instance, a lump sum to pay off debt or meet a big expense like buying a gadget.
-
Interest rate (r)
R is the interest rate on each monthly or quarterly contribution period.
-
Total Number of Contributions (n)
N is the total number of contribution periods or the number of years you will be saving funds.
Example of Sinking Fund
You may have a better understanding of the calculation of sinking funds with an example. Suppose company ABC issues a bond of INR 200 crore for 5 years.
As per the bond, ABC will set up a sinking fund, which will contribute INR 40 crores every year. The same amount will be collected in the sinking funds in the second year. Considering the tenure, ABC will be clearing its debt in the next 5 years.
However, if the company cannot gather the amount annually, it has to pay the total INR 200 crores after the completion of the 5-year bond maturity period. Unable to collect the required funds can lead to a default in payment.
Different Types of Sinking Funds
-
Debt Repayment Sinking Fund
For any debt repayment, like a mortgage, credit card dues, or car loan, you can use a debt repayment fund. You need to contribute a small amount regularly to pay off your debts.
-
Debenture Redemption Fund
Corporations create debenture redemption funds to redeem their debentures on maturity.
-
Preference Shares Redemption Fund
A lot of corporations issue preference shares, which can be redeemable. You must set funds aside every year to buy back those shares on a specific redemption date.
-
Asset Replacement Sinking Fund
This type of sinking fund is crucial for replacing any of your assets, like a laptop. Investing in these funds helps you save gradually to pay the amount in a specific time. You can use this type of fund to replace an asset that depreciates over time.
-
Education Fund
You can also invest in an education fund to build a corpus for your future studies or to gather funds for your child’s education.
-
Capital Expenditure Fund
Companies can use capital expenditure refunds to accumulate funds for large expenses like factory expansion instead of taking loans.
Benefits of Investing in Sinking Funds
Sinking funds allow you to create a corpus for a big expense. Below are the other benefits of investing in sinking funds:
-
Preparing for Unpredictable Expense
Sinking funds help you to store funds for emergency expenses without touching your emergency fund or taking a loan.
-
Reduced Risks
Sinking funds help you to save funds aside; companies lower the risk of defaulting on obligations or being forced into new debt.
-
Interest Income
Sinking funds also help you earn interest on saving your money in a high-yield savings account.
-
Tax Optimisation
You can also avail tax benefits by contributing to some specific sinking funds compared to setting aside profits after tax.
-
Prevents Impulsive Purchases
Investing in these funds may prevent you from making any impulsive purchases. Sinking funds allow you to save for big expenses, which will make you less inclined to buy things you do not need.
How to Start a Sinking Fund?
Follow the steps below to start a sinking fund:
- Identify your main goal for the expense you plan to start a sinking fund, considering the target amount and period.
- Separate your funds from your emergency account, since it can create confusion and lead to accidental spending.
- Break the lump sum target amount into monthly or weekly contributions.
- Choose where you will store your contributions. You choose between a savings account, a recurring deposit, or any other stable investment channel.
- Schedule your contributions for automatic transfers to ensure consistency.
- Monitor your balance and update your daily contributions if your goals or the interest rates change.
Planning to invest in mutual funds? Download the PL Capital Group – Prabhudas Lilladher application to invest in mutual funds from a variety of schemes. Pl also offers you to open a Demat account for free.
Differences Between Sinking Funds and Savings Accounts
Although both of them help you to set aside your funds, sinking funds and savings accounts have different purposes. The table below differentiates sinking funds and savings accounts:
| Parameters | Sinking Funds | Savings Account |
| Goal | Have particular financial goals | For savings and emergencies |
| Usage | Planned a big expense | Daily unplanned needs |
| Accessibility | Can be used for specific goals | Can be used for any expenses |
| Interest Rates | Moderate | Generally lower |
| Discipline | Systematic savings | Can be used at any time |
Differences Between Sinking Funds and Emergency Funds
An emergency fund is created to cover your unexpected emergencies, without taking a loan. To avoid confusion between sinking funds and emergency funds, the table below differentiates between them:
| Parameters | Sinking Funds | Savings Account |
| Goal | Contributes to planned goals or purchases | Contributes for unpredictable circumstances |
| Tenure | Fixed tenure based on the goal | Indefinite |
| Contribution | Pree-determined and objective-based | Flexible |
| Risks | Low-risk investment option | No risks involved |
Final Thought
Sinking funds allow you to build a fund that can cover a particular big expense. A sinking fund helps you to get prepared, whether you are planning to raise funds for buying a gadget as an individual or repay loans as a corporation.
Some of their benefits are risk minimisation, interest income, tax optimisation, and prevention of impulsive purchases.
Opening a Demat account for free with PL allows you to invest in mutual funds. PL offers a platform that helps you choose the best-performing mutual funds.
Frequently Asked Questions
1. What is an example of a sinking fund?
Suppose you want to save INR 12 lakh over 12 months to cover the expense of buying an asset. Using sinking funds, you have to deposit INR 10,000 every month in a separate account until you reach the total amount.
2. What types of obligations can sinking funds be used for by companies?
Companies can start a sinking fund for a lot of purposes. These include redemptions of bonds, preferred shares, and loans. However, they can also be used for asset replacement, capital projects, dividends, and acquisitions.
3. Who contributes to and manages the sinking fund?
Basically, the finance department manages and contributes to the sinking funds per schedule. The treasury department manages the fund assets.
PL Blog
Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.
