Sinking Fund: Types, Advantages & Disadvantages | IBPS PO Prelims & Mains Preparation - Bank Exams PDF Download

Introduction

• A sinking fund is created by the company to revoke the debt.
• This sinking fund is used to make payments to the investors when a company redeems the debt securities or a preferred stock.
• A sinking is used to pay the liability of a company that will come in future.
• A sinking is used to redeem burden of a company, to replace fixed assets, a redemption of stock etc.
• In sinking fund, money is regularly added constantly to assure the investor's confidence.
• A sinking fund is a collection of money done by the company to write off the debt.
• A sinking fund is kept aside by setting a revenue over a certain period of time for the future expense like capital expense repayment of debt etc.
• A sinking fund is generally used when company issue a bond.
• A company has to pay an interest on the issued bonds to the bondholders.
• A company anyhow manage to pay interest from the profit but the time comes when a company has to pay back the principal amount, at that time company use a sinking fund.
• So, the main purpose of a sinking fund is to pay the debt in time.

For Example:
If a company has issued a bond with a maturity of 10 years, so to pay the bond amount after 10 years a company starts putting some money from the starting on a regular basis into a sinking fund so at the end of 10 years company is able to pay on time.

Types of Sinking Fund

• Specific purpose sinking fund : In the specific sinking fund, a company uses this specific purpose sinking fund just to do that particular purpose and nothing else. So it is called specific purpose sinking fund.
• Callable bond sinking fund: As the name describes a callable bond sinking fund means a sinking fund in which a company has a specific call price. So, a callable sinking fund is when needed.
• Purchase back sinking fund: A purchase back sinking fund is used when a company wants to purchase a bond back. A bond can be purchased from the bondholders at two prices, one is market price and the other one is at the sinking fund price.
• Regular payment sinking fund: A regular payment sinking fund is used to make payment regularly to the trustee and many other.

Advantages

• A sinking fund helps the company to pay its liability well in advance.
• A company is able to pay the debt in time because a company has already pulled a money well before.
• A sinking fund is also used to redeem the bond or any other liability in a mid-way also.
• A sinking fund also increases the goodwill of the company by paying the debt in time, and this will increase the faith of investors and attract more investment.

Disadvantages

• When a company uses the sinking fund to buy bonds before maturity, investor losses the interest on that particular time.
• When a company uses this fund to purchase bonds at a discount or par value, so this will lose to the investors.
• When a company has sufficient fund to buy back, the investors cannot take advantage of the company and that will make uncertainty to the investors.